Bonds vs stocks: what’s the difference?

Bonds and shares are different types of investment, although they work in very different ways.
They have different levels of risk, liquidity, and many other factors that we’ll look at in this article. Here is a breakdown of their key differences and similarities:

Ownership vs debt

When you decide to buy shares, you’re basically buying a piece of the ownership of a company, you’re buying what is commonly referred to as a “share”. So what does this mean to you? In essence, it means that you’ll have the right to make a claim on the assets and profits of the company down the line. Bonds, on the other hand, are a more “static” form of investment. You’re essentially lending a small amount of money to either your government or a company, in return for interest payments and the return of your full “loan” when the bonds mature. The most common type of bond is a government bond. These are issued by governments as a means of raising funds for various purposes. If you buy 100 euros of treasury bonds, the government will use the extra income to fund various government operations, pay you some interest in the meantime, and pay you back in 5 to 20 years.

Risk and return

In general, equities offer investors a higher potential return. However, they also come with higher risks: more to lose, more to gain. Share and stock prices can fluctuate dramatically over time, and a market crash or company failure means there’s a real chance you could lose some or all of the money you’ve decided to invest.

Bonds and gilts are generally very safe, it would take a country going bankrupt for you to lose your money. They’re considered the safest investment because they’re backed by the issuing government. Government bonds are also very liquid, which means they are easy to buy and sell.

Income vs growth

Bonds are usually valued and favored by income-seeking investors because they usually pay regular rates of interest, known as coupon payments. They provide a stable and predictable stream of income, especially as they’re generally considered less risky than shares, as they’re less volatile and provide a more secure income stream. They’re a good option to consider if you’re building a portfolio and looking for income, stability, and some form of capital preservation.

Stocks are more focused on trying to appreciate. What is that? It generally refers to the increase in the value of an asset over time. The market price of the shares you buy goes up and makes you money. If you focus on capital appreciation when you invest, you might call yourself a growth investor, and if you’re looking at this type of investment, you might be looking at companies with strong growth potential.

Market influence

The stock market is much more volatile and can be heavily influenced by factors such as economic conditions, the performance of the companies you’ve chosen to invest in, and general investor sentiment. Bond prices are less flexible and are instead directly influenced by interest rates. If the interest rate on, say, the government bonds you’ve bought rises, the price of those bonds will usually fall, and vice versa.

Liquidity

What is liquidity? It usually refers to how easy it is for you to buy or sell an asset in the market without significantly affecting its price. Shares are usually considered to be more liquid than bonds because they can be traded on the stock exchange, even from your smartphone or laptop. This ease of use means that there is usually a large pool of buyers and sellers, making it easy to buy what you’re looking for or get rid of shares you’re no longer interested in.

Bonds are much less liquid, some bonds can have maturities of up to 30 years. Bonds are not traded on the stock market, but on the bond market, which tends to be less centralized and less transparent. Trading volumes are lower and it may be harder to find someone to buy them from you.

Diversification

Stocks have historically offered higher potential returns over a longer period of time than bonds, but as we’ve said, they come with much higher volatility and a greater risk of loss, whereas bonds offer a predictable stream of income through interest and regular payments.

You can mix them, and if you decide to combine stocks and bonds in the same portfolio, you could end up maximizing your potential and achieving a balance between risk and return. During periods of high market volatility or economic uncertainty, the stability and reliability of bonds can help cushion your portfolio from losses in equities. Conversely, the growth potential of equities, in addition to the safety of bonds, can boost your returns in favorable market conditions.

These are more or less the main differences you need to be aware of when considering bonds and shares. Ultimately, if you’re considering using them as a form of investment and savings, the ideal allocation of stocks and bonds in your portfolio will depend very much on factors such as investment goals, risk tolerance, time horizon, and many other individual circumstances.

Your portfolio should be well-diversified and include many different investments. We’ve talked about portfolio diversification before because it helps you manage risk and achieve your financial goals over the long term.

To sum up, stocks give you ownership of a company with the potential for higher returns, but they also come with higher risks and more stress. Bonds are the cooler option, but they offer much lower returns and it can take up to 30 years to recoup your initial investment.