Stocks vs. Bonds: What’s the Difference?

After building up savings or opening a retirement account earmarked for investing, investors most commonly turn to buying stocks or bonds. In fact, a balanced portfolio typically includes both stocks and bonds.

But just because you’ve heard of them or trade them frequently doesn’t necessarily mean all the nuanced differences are clear. Whether you're a newbie or a seasoned investor, this article will explain the difference between stocks and bonds to help you make informed investing decisions.

A Starter Guide to Bonds and Stocks

Bonds and stocks are securities commonly traded in financial markets. Bonds are considered debt securities, while stocks are equity securities.

Stocks

Stocks represent ownership in a company. Purchasing a stock makes you a shareholder in the issuing company and grants you the right to vote at shareholder meetings. Additionally, if the company pays out dividends,  you'll get a share of the company's profits through dividends. Stocks typically offer higher returns than bonds, but they are more volatile and riskier.

Bonds

Bonds are debt securities issued by governments and corporations to raise capital. When you purchase a bond, you're lending money to the issuer typically in exchange for periodic interest payments and the return of your principal when the bond matures. Bonds are generally less volatile than stocks and tend to offer a lower return on investment.

Comparing Stocks and Bonds

Stocks and bonds can be effective assets designed for growing your wealth, and here’s how they compare:

Equity vs. debt

Companies fund their capital with stocks and bonds, otherwise known as equity and debt. Stocks offer investors ownership — equity in a company — while bonds are loans that a company or government entity makes to investors.

Buying a company's stock makes you a shareholder, and you can earn money through capital gains if the company performs well.

When buying a bond, you are lending money to the issuer in exchange for earning interest at a fixed rate. The issuer promises to repay the principal at maturity.

Capital gains vs. fixed income

Another key difference between stocks vs bonds is the way they generate returns. Stocks can generate capital gains, which are profits you earn if you sell a stock for more than you paid for it.

If a company's value increases, its stock will also increase, and you can potentially sell your shares for a profit. This is why stocks are often considered riskier investments — the potential for capital gains is high34 but so is the potential for losses if the company underperforms.

On the other hand, many bonds pay you interest at a fixed rate regularly, such as twice a year or annually. The interest rate is generally lower than what you could earn from stocks, but it is also more stable. This stability can make bonds an attractive choice for investors who want a steadier income stream and are willing to accept a lower return in exchange.

Inverse performance

The state of the economy impacts the performance of stocks and bonds. In a thriving economy, companies tend to perform better potentially leading to higher stock prices and capital gains for investors. But companies usually struggle during economic downturns, leading to lower stock prices and potential losses for investors.

Inversely, bonds often perform better when the economy is struggling. To help protect their money, investors will turn to the relative stability of bonds when concerned about the economy. This can increase demand for bonds, driving up prices and possibly leading to higher returns for bondholders. This relationship between bonds and the economy is inverse because when one rises, the other tends to go down.

Other historical bonds

In addition to traditional bonds issued by companies and governments, other types of bonds have played a significant role in financial history. One example is war bonds, which governments issue to finance military operations during a war. Another example is zero-coupon bonds, which do not pay periodic interest but are issued at a discount and mature at face value. For example, U.S. Treasury bills are zero-coupon bonds.

Stocks vs. Bonds: Which Investment Is Better?

The most suitable investment for you depends on your financial situation, goals and risk tolerance. Both stocks and bonds can play an essential role in a diversified investment portfolio.

Stocks, also known as equities, represent ownership in a company and offer the potential for capital appreciation as the company's value grows. Stocks carry more risk than bonds because their value can fluctuate in response to changes in the market or the company's financial performance. As a result, stocks are generally more suitable for investors with a higher risk tolerance who prefer to invest long term.

Bonds are considered less risky than stocks because they offer a fixed income stream and a predictable principal return. But the value of bonds can still be affected by changes in interest rates and the issuer's creditworthiness. Bonds can be an option t for risk-averse investors who seek a stable and predictable return on their investment.

How Do You Buy Stocks?

Here is how to get started investing in stocks:

Open a brokerage account: To buy stocks, you need to open a brokerage account. You can typically open an account online in a few minutes by providing your personal details. Some online brokerages may require a minimum deposit to open an account.

Choose the stocks to buy: Once you have opened a brokerage account, you can search for stocks using the brokerage's trading platform or app. Search for stocks by name or ticker symbol, and use various filters and tools to find stocks that meet your investment criteria.

Place an order: To buy your preferred stocks, place an order through your brokerage account. You can use different types of orders, including market orders, limit orders and stop orders. A market order is an instruction to buy or sell a security at the prevailing market price. If you have a price in mind, a limit order allows you to specify the limit price at which you want to buy or sell the security. A stop order (commonly used as a stop-loss order) sets a price as a trigger for an order to execute.

Pay for the stocks: After placing your orders, you will be required to pay for them using funds from your brokerage account. You can link your brokerage account to your bank account to facilitate funds transfer.

How Could Investors Make Money With Bonds?

You can potentially make money with bonds in two ways:

Interest payments: You earn income from the periodic interest payments made on the bond. These payments are usually paid out semi-annually but can also be paid out monthly or annually.

Capital appreciation: If you buy a bond and hold it hoping it to increase in value, you can potentially sell it for a higher price at the secondary market. This can happen if interest rates fall after you buy the bond, making your bond more attractive to investors.

Stocks vs. Bonds: How to Choose the Right Investment for Your Portfolio

Stocks and bonds are different investment types that you can combine in a diversified investment portfolio. Stocks represent ownership in a company and hold the potential for capital appreciation. They come with a higher risk because their value can generally change more quickly and frequently in response to several factors.

Bonds are debt securities issued by governments, municipalities or corporations that may offer a fixed income stream and a predictable return of principal at maturity. Still, their value can be affected by changes in interest rates and the issuer's creditworthiness. The appropriate mix of these investments will depend on an individual's financial situation, goals, and risk tolerance. Gain more control over your investments with Moomoo. With the support of powerful tools, real-time data, and AI support alerts– you can trade like a Pro.