Updated: July 6, 2020
There are many types of paper assets and investments. But two of the biggest components of most portfolios are stocks and bonds. Even mutual funds and UITFs are mostly composed of stocks and/or bond investments.
And many people ask…
What are the differences between stocks and bonds? What are the similarities? And where should I invest among the two?
Stocks and bonds have their own pros and cons. To know where you should invest is not as simple as learning the advantages or disadvantages of each.
So how should you decide?
Stocks and bonds: the basic difference
When you invest in stocks, you become part-owner of the company. You gain what is called, equity on the business. Meanwhile, when you invest in bonds, you’re lending money to the company. They incur debt from you.
This basic difference dictates how an investor makes money from stocks and bonds.
As a stockholder, you make money as the company grows, either from stock price appreciation or through dividends. Meanwhile, as a bond holder, you make money from debt interest payments of the company to you.
Your financial goals
Given the basic differences above, it can now be said that if your financial goal is long-term growth for your portfolio, then you should invest in stocks. But if you’re looking for a steady stream of income, then bond investments is your better choice.
Stocks will always have the best growth in value for your investment. A careful and diverse selection of stocks can multiply your portfolio’s value over time.
Meanwhile, bonds pay fixed interests in expected intervals, usually once or twice a year, some quarterly. Unlike stocks, where you don’t really know when dividends will be paid out. Some stocks don’t pay dividends at all.
Your risk tolerance
Another consideration for investing in stocks vs bonds is your risk tolerance.
For bonds, the amount of your investment, under normal circumstances, will never change over the life of the bond. So if you invest P100,000 on a 7-year bond, then you will receive the same amount of P100,000 at the end of those 7 years.
Unlike in stocks, the price of the shares you own can either go up or down. If you invest P100,000 and then sell your shares after 7 years, you could end up with either less than P100,000 or hopefully, more than that amount.
Moreover, if a company goes bankrupt, bond holders get paid first from the liquidation of the company’s assets. Stock holders will have to wait until all debts and liabilities are paid before they can get money, if there’s any left at all.
These are the reasons why conservative investors generally prefer investing in bonds. And why those who are comfortable with taking higher risks like having stock investments in their portfolio.
It’s better to invest in both
I believe that there’s always room for both stocks and bonds in anyone’s portfolio. You don’t really have to choose one over the other.
For those who are seeking growth and thus, investing more in stocks. Allocating a percentage of your portfolio in bonds can help balance your risk because when stock prices fall, safer asset classes such as bonds usually go up.
Meanwhile, for risk-averse investors who choose an income-oriented portfolio of bonds, an portion of investment in stocks can provide valuable protection against inflation.
That is because the amount of interest that a bond pays is usually fixed. So an increase in inflation can reduce the value of those payments. Stocks will help you protect your money from inflation because stock values often rise faster than inflation.
To summarize, stock investments will allow you to hedge against inflation; while bonds will provide a dependable safety net against stock market losses.
Thus, a mixture of stocks and bonds can help investors to maximize profits and minimize risks
Further reading for beginners:
If you’re new to investing and would like to learn more how the stock market and bond investments work, then you can read these articles: