Key Differences Between Bonds and Stocks

Key Differences Between Bonds and Stocks

For people who want to start getting into investing, the investment world probably looks incredibly alien. It can be easy to overcomplicate the image of investing and to lose yourself in the trees when the forest is actually incredibly easy to see. For beginning investors who are looking to start a portfolio, the two main aspects of investing to understand are stocks and bonds.

Stocks are shares that a person is able to own in a business, while a bond is a unit of debt that businesses owe, with interest, to whoever owns the bond. Typically, a balanced portfolio will utilize both stocks and bonds, because there are substantial benefits to both. Here’s some information to help you understand the difference between stocks and bonds…

Stocks Are a Higher Risk Investment

The first thing to note about stocks is that they are essentially a much higher risk investment, but have the potential to yield a much higher return. Because stocks are ownership in a company, it means that you are on the line for any business losses, as well as gains. Essentially, stocks put you in the same basket as the company you are investing in, so you’ll get burned or flourish with them, either way.

Bonds Are Safe and Reliable

While stocks are a high risk/high reward investment, bonds are quite the opposite. Because you are essentially lending company money that they must pay back with interest (by a specified date), bonds are a much safer investment that you are unlikely to lose money on. However, by the same nature, your gains from bonds are always going to be tempered within a specific amount, due to the interest rate.

Stocks Generally Have Higher Wealth-Growing Potential

If your goals with investing are to generate wealth, then stocks are absolutely a necessary commodity, especially since they open the door to investments like IPOs. Unless you are starting with a substantial amount of capital, bonds will never generate the type of returns that are going to push your wealth to a new level. Splitting your investment up between stocks of a variety of companies and industries puts your eggs in enough baskets that it can mitigate risk, but generate higher returns than simply waiting for interest to generate from bonds.

Bonds Can Be Very Good for Retirement

Just because you need stocks to grow your wealth, you shouldn’t leave bonds out of your portfolio. If you are primarily building a portfolio to help you reach your retirement goals, then bonds can be an excellent way to get your savings to compound over time. This makes it possible for you to easily calculate the amount that you need to put into bonds, in order to reach a specific number by a specific year, which is ideal when trying to pick a retirement age.

It’s Critical to Diversify with Both

At the end of the day, everyone should utilize both stocks and bonds in their portfolio. The ultimate key to investing is diversification. Putting all of your eggs in one basket is likely going to end up leaving you heartbroken. A healthy ratio of stocks and bonds, depending on your goals, is a great way to approach investing. 

According to market theory, using a wide diversification of both stocks and bonds as a long-term investment strategy (30+ years) is almost assuredly going to pay off, over time, and usually in sizeable amounts. No matter what, you are nearly certain to end up with more money than you would have had if you had left your money to rot in a savings account.

Age May Determine the Ratio You Want

The ratio of stocks and bonds that you should strive to reach is largely dependent on your goals and. even more specifically, your age. When you are young, investing in a diversified portfolio of stocks can be an excellent strategy, since the volatility of your investments will be mitigated, over time. For example, a healthy mix of 85% stocks and 15% bonds might be a great investment plan for someone in their 20s or 30s. On the other hand, when you are older, the potential volatility of stocks might dissuade you from that path, whereas bonds are a surefire way to grow the capital you already have, but with far less potential for losses.