Inthe investment world, stocks are the life of the party.
Bonds, quite frankly, are boring.
Even if youre a set-it-and-forget-it investor, just watching stocks can be thrilling.
But who the heck starts a conversation by talking about what the bond market was doing today?
Heres a primer on stocks vs. bonds and why you oughta own both.
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What Is a Stock?
A stock is, essentially, a small unit of ownership (think share) in a company.
Stocks are usually bought and sold on an exchange, like the New York Stock Exchange.
While stocks are often described as a risky investment, thats an oversimplification.
That shields you from the risk of any one company failing.
Investing in stocks is typically the way you grow your money and build a nest egg.
Even though the stock market can be volatile, you shouldnt be scared by short-term losses.
Long-term growth is what youre after.
When youbuy stockin a company, you become the owner of a tiny fraction of the company.
You make money on stocks in one of two ways.
You would think that this happens because the company is making money.
But sometimes a stocks price will skyrocket even though the issuing company is losing money.
Or it will plummet even though the company is doing fine.
Thats because stock markets tell us investor predictions, rather than the current reality.
Dividend Payments
Sometimes companies distribute part of their profits to shareholders by paying a dividend.
Think the Johnson & Johnsons and Procter and Gambles of the world.
A company thats in startup mode needs to reinvest its profits and probably wont pay dividends.
You could become a millionaire by picking the next Apple or Amazon.
But you could also lose your entire investment if a company goes out of business.
What Is a Bond?
Bonds are basically loans issued to borrowers like governments or corporations.
When you invest in bonds, you become a creditor.
You get paid as long as the corporation or government doesnt default on its debt.
Then at the end of five years, youd get your $10,000 back.
Bonds dont have that kingmaker potential that stocks do.
Bonds are generally safer than stocks.
But again, thats an oversimplification.
Like stocks, bonds also fire off the risk gamut.
U.S. Treasury bonds are backed by the federal government, so youre essentially guaranteed to get paid back.
The downside of Treasury securities is that you get extremely low interest payments because youre barely taking any risk.
Your money will buy less and less over time.
Some bonds can be quite risky, though.
Just as with stocks, investing in any single bond can be a dangerous investment strategy.
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Between the two, stocks are the riskier investment, but that riskcanpay off in a big way.
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Stocks offer unlimited potential returns, while bonds offer fixed income.
A stock price can technically soar to infinity, so theres no limit on your potential profits.
The benefit of bonds is that the issuer is contractually obligated to make interest payments.
That fixed income is especially valuable if youre on aretirement budget.
Although you could also make money buying and selling bonds, this is risky for most people.
Stability and regular interest payments, rather than big returns, are typically the reasons you invest in bonds.
Corporations and governments issue bonds, but only corporations issue stocks.
Both corporations and governments use the bond market to finance debt.
Only corporations issue stocks.
Usually, companies do this to raise cash to fuel their growth.
Stocks are more volatile than bonds, meaning their prices fluctuate more.
Still, that shouldnt worry you if youre a decade or more away from retirement.
Your money has time to recover if the stock market crashes.
Then you shift more money into safer asset classes like bonds as you get older.
Shareholders get paid after bondholders if a company files for bankruptcy.
Once all those claims have been paid, bondholders come next in line.
Owners of common stock come dead last in line.
Theres often nothing left for common stock investors after bankruptcy.
According to conventional wisdom, stock prices and bond prices move in opposite directions.
But in recent years, stock and bond prices havent always moved inversely.
For instance, during the COVID-19 panic in March 2020, both stock and bond prices crashed.
When interest rates rise, bonds tend to drop in price.
The reason is that rising interest rates allow bond investors to earn more money.
Bonds vs. Stocks: Whats the Right Mix?
The reason is that when youre younger with decades left until retirement, you want your money to compound.
You also have plenty of time to recover from a stock market crash.
It will gradually rebalance your mix of stocks and bonds as you get closer to retirement.
So if youre 40, youd aim to have 70% stock investments and 30% bonds.
Regardless of what mix of assets you choose, the important thing is tostart investingalready.
Time is the best weapon you have for making that money grow.
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Stocks and bonds are both types of investments, but thats where the similarities end.
Stocks are ownership stakes in a company, while bonds are a loan to a company or government entity.
Instead, they pay fixed interest over time.
However, over long periods of time, stocks tend to outperform bonds as market fluctuations even out.
And besides, fund management companies are usually making these decisions for investors.
Robin Hartill is a certified financial planner and a senior writer at The Penny Hoarder.
Send your tricky money questions to[email protected]or chat with her inThe Penny Hoarder Community.
Contributor Dave Schafer updated this report.
