Considerations When Choosing Stock Versus Bond Investments

Stocks and bonds are two of the most common investments, but they have some important differences that may impact your decision making. As you design your portfolio, you need to decide whether stocks or bonds are right for your goals and how much you want to invest in each type.

When you buy stocks, you purchase a small ownership share of a company. This means you're entitled to some of the profits. When the company makes money, they could send their shareholders a cash payment, known as a dividend. In addition, if a company you buy into performs well, you could sell your shares to another investor for a gain.

With bonds, you're making a loan to a company, government or other organization for a set amount of time. During this time, the bond issuer will pay you interest. At the end of the bond term, they pay back your loan.

These differences between stocks and bonds might impact the way you choose to invest and how you structure your portfolio.

Investing in bonds versus stocks

Bonds are typically a more stable and predictable investment than stocks. Because they pay a set interest rate, you start earning money right away. In addition, the bond issuer also promises to pay back your initial contribution at the end of the bond term. You should get your initial investment back, plus interest. However, there are situations when bonds can lose money. For example, a bond issuer may run into financial trouble and be unable to pay back your loan. However, this is less common than losing money on the stock market. 

Stocks don't have any set interest rate, so there's less assurance that you'll make back more than what you invest. The company doesn't have to pay a dividend, and if they start performing badly, the value of your shares could go down.

The main advantage of stocks is that they have a higher long-term return rate, on average. While they're more likely to face larger ups and downs which sometimes result in losses in the short term, the stock market has historically earned more per year than bonds.

How goals impact investment choices

Generally, bonds are a better fit when you're risk averse. They also make sense when you are close to a financial goal and want to protect your savings. Stocks are often a good choice when you're trying to grow your savings for the long term and want a higher return. Let's see how they fit for some specific situations.

Saving for retirement

When you're younger and in the earlier stages of your career, it may make sense to have more of your savings in stocks. Because you won't need your money for many years, you can wait out the market swings in exchange for higher long-term growth.

As you get closer to retirement, you may want to shift your portfolio to investing in bonds instead of stocks. That way, you protect your savings from market fluctuation while still earning a smaller but more consistent return.

Generating income

If you're relying on your investments for money right now, bonds can be a better choice. As soon as you buy a bond, you start receiving the interest payments. Some stocks also specialize in paying consistent dividends and could also serve this goal, but bonds still tend to be a better fit when you need income.

Leaving an inheritance 

If you're building an inheritance for some point in the future, stocks can help grow that nest egg even more. But if you're trying to preserve an inheritance that you might be leaving behind soon, bonds could be the safer move.

In addition, consider whether your heirs might need money right away and would prefer bonds. If they're focused on building their own long-term wealth, they may prefer stocks.

Saving for the future

The closer you are to needing the money, the more bonds make sense. When you're years away from needing to use the funds, you can focus more on growth with stocks. For example, if you're saving for your kids' education while they're still toddlers, it might make sense to prioritize stocks for longer-term growth. On the other hand, if you're looking to buy a house within a year or two, you may prefer more bond investments to help toward that goal.

Personalizing your portfolio

Depending on your goals, it can make sense to prioritize either bonds or stocks. Regardless of which you purchase, a key part of investing is diversification, so keep a mix of assets and avoid having all your eggs in one basket.

Bond investors may still want to have part of their portfolio in stocks for long-term growth. On the other hand, stock investors typically keep some amount in bonds to protect their savings during downturns.

For help with this decision, consider meeting with a financial advisor. They can fine-tune your portfolio with the right balance of stocks and bonds based on your goals.