Bonds vs. Stocks: A Beginner's Guide – Newsweek Vault (2024)

A common question new investors ask is, “Should I invest in stocks or bonds?” Both stocks and bonds are securities issued by companies or other organizations as a way to raise money.

But stocks and bonds are nearly opposite types of investments and come with different risks and rewards. This article will explain the difference between stocks and bonds, and how to choose the right investment strategy for you.

Vault’s Viewpoint on Bonds vs. Stocks

• A stock is an investment in a company’s assets and earnings.
• A bond is an investment in a company or government’s debt.
• Both bonds and stocks should be part of a well-diversified portfolio.

Investing in Stocks vs. Bonds

Here are the biggest differences between bonds versus stocks:

What Are Stocks?

A stock represents a share of ownership in a company and gives you a small claim over that company’s earnings and assets. As the company performs well and becomes more valuable, the value of your shares increases. But if the value of the business falls, your shares drop.

Stocks are bought and sold on exchanges, and some companies will sell shares directly to investors. But most will require purchasing shares through an online brokerage account.

When you invest in stocks, the goal is to find high-quality companies with shares that are moderately priced. Then you can hold onto your shares for a long time and watch the value grow over time. And some financially stable companies pay quarterly dividends to investors.

Types of Stocks

Stocks can be categorized in a few different ways—by industry, company size or location. Here are the most common types of stocks you’ll encounter:

• Growth stocks: Growth stocks refer to companies with share prices, earnings or revenue that are growing faster than the overall market. Many investors choose growth stocks because they expect the shares to quickly increase in value. Amazon is a good example of a growth stock.
• Value stocks: A value stock is one that’s trading below what you’d expect given the company’s fundamentals. If you invest in value stocks, it’s because you believe the company is underpriced and its shares will rebound in the future. Procter & Gamble is a good example of a value stock.
• Large-cap stocks: Large-cap stocks are companies with a market capitalization of more than $10 billion. These stocks are more stable and tend to be safer investments. Wal-Mart and Apple are examples of large-cap stocks.
• Mid-cap stocks: Mid-cap stocks are companies with a market capitalization between $2 billion and $10 billion. They’re often new, fast-growing companies that are starting to become more stable but still have room to grow. Avis Budget Group and Chewy are examples of mid-cap stocks.
• Small-cap stocks: Small-cap stocks are companies with a market capitalization between $300 million and $2 billion. Small-cap stocks have the potential for significant growth, but can be highly volatile. ELF Beauty was a small-cap stock, but was moved to the S&P MidCap 400 index in January 2024.

Pros and Cons of Stocks

Pros

• Potential for high returns: Stocks consistently perform well over the long term, and the S&P 500 has an average annual return of 10%.
• Dividend income: Investing in a company that pays dividends can provide you with an additional source of income.
• Start small: You don’t need much money to start investing in stocks—you can start small and grow your investment over time.

Cons

• Volatility: The stock market can be volatile, and a sudden drop in shares will temporarily hurt your investment.
• Potential losses: There’s no guarantee you’ll earn money by investing in stocks. And if the company goes bankrupt, shareholders are the last to be repaid.
• Requires research: You’ll have to pay close attention to the market and monitor the performance of your shares.

See Also

How to build the perfect investment portfolio

What Are Bonds?

When you buy a bond, you act as a partial lender to that company. Companies or governments issue bond coupons to raise money from various investors. In return the organization agrees to pay an annual interest rate and to repay the principal once the bond matures. Interest payments are typically made semi-annually.

The bond’s value can fluctuate while you own it, but if you hold the bond until the maturity date, you’ll earn the same amount of interest. For that reason, bonds are considered a much safer type of investment and can generate a consistent source of income.

Types of Bonds

There are three types of bonds, and each comes with a different level of risk:

• Municipal bonds: Municipal bonds are issued by states, cities and counties to finance projects like fixing roads and building schools. These bonds are considered safe investments, but they’re not entirely free from risk. Any interest you earn on municipal bonds is typically exempt from federal income taxes.
• Government bonds: Government bonds are the safest type of bond, and are generally considered a risk-free investment. These bonds are backed by the federal government so you’re practically guaranteed to receive your principal and interest upon maturity.
• Corporate bonds: Corporate bonds are issued by private and public companies, and are the riskiest type of bond. If you choose to invest in corporate bonds, you’ll need to pay close attention to that company’s credit rating.

Pros and Cons of Bonds

Pros

• Low-risk investment: Bonds tend to be a low-risk investment, especially if you buy Treasury bonds. There’s very little risk of permanent loss when you invest in bonds.
• Stable source of income: Most bonds pay interest semi-annually and provide a regular source of income. This can be especially attractive to retirees who can use these funds to supplement their retirement income.
• Diversification: Investing in bonds is an excellent way to diversify your portfolio outside of the stock market.

Cons

• Low returns: Bonds tend to be a low-risk investment but also generate much lower returns, especially when compared to the stock market. If you’re solely investing in bonds, you’ll miss out on significant returns.
• Sensitive to interest rate changes: Bonds tend to have an inverse relationship with interest rates so when rates rise, bond prices usually fall. So sudden changes in interest rates can create instability in the bond market.
• More volatility in recent years: The bond market has become increasingly volatile in recent years, though it’s still lower than the stock market volatility.

How to Choose Between Stocks or Bonds

Choosing between stocks versus bonds really comes down to your financial goals and how close you are to retirement. Historically, bonds are a more conservative investment since they provide a fixed rate of return. Once the bond matures, you’re guaranteed to receive your principal back and a certain amount of interest no matter what happens in the market.

The biggest disadvantage of bonds is your returns will be much lower than what you could make in the stock market. If you have a long investing timeline, investing in stocks may be a good choice. But you will have to invest some time and energy in researching different companies and monitoring the performance of the stocks you buy.

For most people, it doesn’t have to be an either-or choice. You can invest in bonds and stocks. That way, you have a long-term growth strategy but are also giving your portfolio some protection against market volatility.

Related Articles

• Robinhood Review
• Best Online Brokers for Stock Trading
• Best Investment Apps
• Best Online Brokers for Stock Trading