A:

This is a common question among investors. Stocks and bonds differ dramatically in their structures, payouts, returns and risks. In order to answer this question, we need to go through a brief description of both stocks and bonds.

A bond is a form of debt with which you are the lender instead of the borrower. Bonds are contractual loans made between investors and institutions that, in return for financing, will pay a premium for borrowing, known as a coupon. Additionally, the bond's face value is returned to the investor at maturity. The guarantee of payback and all coupon payments relies solely on the ability of the borrower to generate enough cash flow to repay bondholders.

Stocks are a form of ownership; they represent participation in a company's growth. Generally, investors are given no promises about returns of the initial investment. In fact, the profitability of the investment depends almost entirely upon rising stock price, which, at the most fundamental level, relates directly to the performance and growth (increasing profits) of the company.

So this leads to the original question: which security is better? The answer is neither. Stocks and bonds both have their pros and cons depending on what you are looking for. For example, risk-averse investors looking for safety of capital and who prefer a known periodic payment structure (i.e. coupon payments) for a limited time frame would be better off investing in bonds. On the other hand, investors who are willing to take on greater risks than bondholders and who would prefer the benefit of having partial ownership in a company and the unlimited potential of a rising stock price would be better off investing in stocks.

However, the disadvantage of stocks versus bonds is that stocks are not guaranteed to return anything to the investor while the coupon payments and principal of bonds are. Thus, the possibility for high returns is greater with stocks but so is the possibility of losing money.

For most investors, a combination of stocks and bonds is the best situation. By diversifying your investments and putting some money into both stocks and bonds you ensure some safety while leaving some opportunity for above-average returns in your stock investments.

For further reading, check out our Stock Basics Tutorial and Bond Basics Tutorial.

RELATED FAQS
  1. Do long-term bonds have a greater interest rate risk than short-term bonds?

    The answer to this question lies in the fixed income nature of bonds and debentures, often referred to together simply as ... Read Answer >>
  2. Are high-yield bonds better investments than low-yield bonds?

    Most bonds typically make periodic payments, known as coupon payments, to the bondholder. A bond's indenture, which will ... Read Answer >>
  3. What is accrued interest, and why do I have to pay it when I buy a bond?

    A bond represents a debt obligation whereby the owner (the lender) receives compensation in the form of interest payments. ... Read Answer >>
  4. How does an investor make money on bonds?

    Bonds are part of the family of investments known as fixed-income securities. These securities are debt obligations, meaning ... Read Answer >>
  5. What are the key factors that will cause a bond to trade as a premium bond?

    Learn about the primary factor that can cause bonds to trade at a premium, including how national interest rates affect bond ... Read Answer >>
  6. How does the money from the interest on my bond get to me?

    When you buy a regular coupon bond, you are entitled to a coupon, which is typically paid at regular intervals, and the face ... Read Answer >>
Related Articles
  1. Retirement

    Should I Invest in Bonds After I Retire?

    Yes, retirees should invest in bonds, but remember that not all bonds are safe investments. Seek the help of a financial advisor.
  2. Bonds & Fixed Income

    Bond Portfolios Made Easy

    Bonds have typically been viewed as stocks' less-glamorous sidekick, but they deserve a little more respect from investors.
  3. Bonds & Fixed Income

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
  4. Home & Auto

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  5. Options & Futures

    Top 6 Uses For Bonds

    We break down the stodgy stereotype to see what these investments can do for you.
  6. Bonds & Fixed Income

    Corporate High-Yield Bonds vs. Equities

    Equities and corporate bonds often play a significant role regarding the diversification of an investor's portfolio. We put both asset classes in contrast.
  7. Mutual Funds & ETFs

    Key Strategies To Avoid Negative Bond Returns

    It is difficult to make money in bonds in a rising rate environment, but there are ways to avoid losses.
  8. Investing

    Advising FAs: Explaining Bonds to a Client

    Most of us have borrowed money at some point in our lives, and just as people need money, so do companies and governments. Companies need funds to expand into new markets, while governments need ...
  9. Investing Basics

    What is a Premium Bond?

    A premium bond is one that trades above its face or nominal amount.
  10. Bonds & Fixed Income

    Find The Right Bond At The Right Time

    Find out which bonds you should be investing in and when you should be buying them.
RELATED TERMS
  1. Bond

    A debt investment in which an investor loans money to an entity ...
  2. Discount Bond

    A bond that is issued for less than its par (or face) value, ...
  3. Current Yield

    Annual income (interest or dividends) divided by the current ...
  4. Required Yield

    The return a bond must offer in order to be a worthwhile investment. ...
  5. Bunny Bond

    A type of bond that offers investors the option to reinvest coupon ...
  6. Zero-Coupon Bond

    A debt security that doesn't pay interest (a coupon) but is traded ...
Hot Definitions
  1. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  2. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  3. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  4. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  5. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
  6. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
Trading Center