Which is better to invest in stocks or bonds?
Stocks offer the potential for higher returns than bonds but also come with higher risks. Bonds generally offer fairly reliable returns and are better suited for risk-averse investors.
Stocks offer an opportunity for higher long-term returns compared with bonds but come with greater risk. Bonds are generally more stable than stocks but have provided lower long-term returns. By owning a mix of different investments, you're diversifying your portfolio.
Pros | Cons |
---|---|
Can offer a stream of income | Exposes investors to credit and default risk |
Can help diversify an investment portfolio and mitigate investment risk | Typically generate lower returns than other investments |
Investing in stocks offers the potential for substantial returns, income through dividends and portfolio diversification. However, it also comes with risks, including market volatility, tax bills as well as the need for time and expertise.
The obvious answer is that stocks are riskier than bonds, and investors are risk averse and thus demand a higher return when they buy stocks.
The Bottom Line
Bonds can contribute an element of stability to almost any diversified portfolio – they are a safe and conservative investment. They provide a predictable stream of income when stocks perform poorly, and they are a great savings vehicle for when you don't want to put your money at risk.
In general, stocks are riskier than bonds, simply due to the fact that they offer no guaranteed returns to the investor, unlike bonds, which offer fairly reliable returns through coupon payments.
Face Value | Purchase Amount | 30-Year Value (Purchased May 1990) |
---|---|---|
$50 Bond | $100 | $207.36 |
$100 Bond | $200 | $414.72 |
$500 Bond | $400 | $1,036.80 |
$1,000 Bond | $800 | $2,073.60 |
Key Points. Pros: I bonds come with a high interest rate during inflationary periods, they're low-risk, and they help protect against inflation. Cons: Rates are variable, there's a lockup period and early withdrawal penalty, and there's a limit to how much you can invest.
What are the disadvantages of bonds? Although bonds provide diversification, holding too much of your portfolio in this type of investment might be too conservative an approach. The trade-off you get with the stability of bonds is you will likely receive lower returns overall, historically, than stocks.
Who should not invest in stocks?
If you have debt, especially credit card debt, or really any other personal debt that has a higher interest rate. You should not invest, because you will get a better return by merely paying debt down due to the amount of interest that you're paying.
Bonds rated below Baa3 by ratings agency Moody's or below BBB by Standard & Poor's and Fitch Ratings are considered “speculative grade” or high-yield bonds. Sometimes also called junk bonds, these bonds offer higher interest rates to attract investors and compensate for the higher level of risk.
Risk of Loss
Stocks are most susceptible to losses in the short term. Even in the long term, though, there's no guarantee that you'll generate the returns you want.
During a bear market environment, bonds are typically viewed as safe investments. That's because when stock prices fall, bond prices tend to rise. When a bear market goes hand in hand with a recession, it's typical to see bond prices increasing and yields falling just before the recession reaches its deepest point.
In every recession since 1950, bonds have delivered higher returns than stocks and cash. That's partly because the Federal Reserve and other central banks have often cut interest rates in hopes of stimulating economic activity during a recession. Rate cuts typically cause bond yields to fall and bond prices to rise.
There are two ways that investors make money from bonds. The individual investor buys bonds directly, with the aim of holding them until they mature in order to profit from the interest they earn. They may also buy into a bond mutual fund or a bond exchange-traded fund (ETF).
- Money market funds.
- Mutual funds.
- Index Funds.
- Exchange-traded funds.
- Stocks.
- Alternative investments.
- Cryptocurrencies.
- Real estate.
Higher yields can help reduce risk by acting as a buffer to additional rate increases while also providing a stronger base for future returns if the Federal Reserve begins cutting rates in the future. As a result, bonds may provide you with attractive yields at a lower risk profile than we've seen in recent years.
Vanguard's active fixed income team believes emerging markets (EM) bonds could outperform much of the rest of the fixed income market in 2024 because of the likelihood of declining global interest rates, the current yield premium over U.S. investment-grade bonds, and a longer duration profile than U.S. high yield.
Should I only buy bonds when interest rates are high? There are advantages to purchasing bonds after interest rates have risen. Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels.
What happens if you hold a bond to maturity?
Investors who hold a bond to maturity (when it becomes due) get back the face value or "par value" of the bond. But investors who sell a bond before it matures may get a far different amount.
If you're the risk-averse type who truly can't bear the thought of losing money, bonds might be a more suitable investment for you than stocks. If you're heavily invested in stocks, bonds are a good way to diversify your portfolio and protect yourself from market volatility.
After 20 years, the Patriot Bond is guaranteed to be worth at least face value. So a $50 Patriot Bond, which was bought for $25, will be worth at least $50 after 20 years. It can continue to accrue interest for as many as 10 more years after that.
After weighing your timeline, tolerance to risk and goals, you'll likely know whether CDs or bonds are right for you. CDs are usually best for investors looking for a safe, shorter-term investment. Bonds are typically longer, higher-risk investments that deliver greater returns and a predictable income.
Series EE savings bonds are a low-risk way to save money. They earn interest regularly for 30 years (or until you cash them if you do that before 30 years). For EE bonds you buy now, we guarantee that the bond will double in value in 20 years, even if we have to add money at 20 years to make that happen.
References
- https://www.britannica.com/money/investing-i-bonds
- https://www.investopedia.com/ask/answers/how-does-investor-make-money-on-bonds/
- https://www.fool.com/investing/how-to-invest/bonds/patriot-bonds/
- https://investor.vanguard.com/investor-resources-education/article/are-bonds-a-good-investment-right-now
- https://www.fool.com/investing/how-to-invest/bonds/
- https://smartasset.com/investing/should-i-move-my-401k-to-bonds
- https://www.usbank.com/investing/financial-perspectives/market-news/interest-rates-affect-bonds.html
- https://www.investopedia.com/ask/answers/advantages-and-disadvantages-buying-stocks-instead-of-bonds/
- https://retirehappily.net/five-reasons-why-you-should-not-invest-in-the-stock-market/
- https://www.finra.org/investors/insights/what-to-know-high-yield-bonds
- https://americanfundsretirement.retire.americanfunds.com/planning/what-is-asset-allocation/stocks-and-bonds.html
- https://www.experian.com/blogs/ask-experian/pros-cons-of-buying-stocks/
- https://www.fidelity.com/learning-center/trading-investing/bond-market-outlook
- https://corporate.vanguard.com/content/corporatesite/us/en/corp/articles/why-investors-should-consider-emerging-market-bonds-2024.html
- https://time.com/personal-finance/article/savings-bonds-guide/
- https://www.nber.org/digest/dec97/how-much-do-stocks-outperform-bonds
- https://www.treasurydirect.gov/savings-bonds/ee-bonds/
- https://www.investor.gov/introduction-investing/investing-basics/glossary/bonds-selling-maturity
- https://smartasset.com/investing/pros-and-cons-of-stocks
- https://www.prudential.com/financial-education/advantages-disadvantages-investing-bonds
- https://www.cnn.com/cnn-underscored/money/cds-vs-bonds
- https://www.investopedia.com/investing/bond-advantages/
- https://fortune.com/recommends/investing/what-are-bonds/
- https://www.nerdwallet.com/article/investing/the-best-investments-right-now