Stocks and bonds are the two building blocks of most investment portfolios. You will see them mentioned in almost every discussion about retirement accounts, index funds, and asset allocation. Yet many beginners are not entirely sure what the difference is – or why most portfolios hold some of each.
This guide explains what stocks and bonds are, how investors earn money from each, the risks involved, and how the two tend to work together.
What Is a Stock?
A stock (also called a share or equity) represents a small piece of ownership in a company. If a company has one million shares and you own 1,000, you own 0.1% of that business.
As an owner, you share in the company’s success – and its failures. There is no promise that you will get your money back, and no fixed payment. What you receive depends on how the business performs and how other investors value it.
How stock investors make money
- Price appreciation: if the company grows its profits and investors become willing to pay more for its shares, the share price rises and you can sell for more than you paid.
- Dividends: some companies pay part of their profits to shareholders in cash, often every quarter. Dividends are not guaranteed and can be cut.
What Is a Bond?
A bond is essentially a loan. When you buy a bond, you lend money to a government, agency, or company. In return, the issuer promises to:
- pay you interest (called the coupon) at regular intervals, and
- repay the original amount (the face value or principal) on a set maturity date.
For example, a 10-year bond with a $1,000 face value and a 4% coupon would typically pay $40 of interest per year for ten years, and then return the $1,000 at maturity – as long as the issuer does not default.
How bond investors make money
- Interest payments, which are usually the main source of return.
- Price changes, if you sell a bond before maturity. Bond prices rise when interest rates fall and fall when rates rise.
Stocks vs. Bonds at a Glance
| Stocks | Bonds | |
|---|---|---|
| What you own | A share of a company | A loan to an issuer |
| Main source of return | Growth in value, dividends | Interest payments |
| Typical volatility | Higher | Lower (varies by type) |
| Long-term growth potential | Higher, historically | Lower, historically |
| Priority if the issuer fails | Paid last | Paid before shareholders |
| Common role in a portfolio | Growth | Stability and income |
Understanding the Risks
Risks of stocks
- Market risk: the whole stock market can fall sharply, sometimes by 30% or more during recessions or crises.
- Company risk: an individual company can struggle or go bankrupt, and its shares can become worthless.
- Volatility: prices can swing widely from day to day and year to year, which can be emotionally difficult.
Risks of bonds
- Interest rate risk: when rates rise, the market value of existing bonds falls. Longer-maturity bonds are more sensitive.
- Credit (default) risk: the issuer may be unable to pay. Government bonds from stable countries are generally considered lower risk than bonds from companies with weak finances (“high-yield” or “junk” bonds).
- Inflation risk: fixed interest payments lose purchasing power when prices rise. Read more in our guide to how inflation erodes savings.
Why Most Portfolios Hold Both
Stocks and bonds play different roles. Stocks have historically offered higher long-term growth but with bigger swings. High-quality bonds have generally been steadier and have often – though not always – held up better when stocks fell. Combining them can smooth the ride.
The mix between them is called asset allocation. A common illustration is a “60/40” portfolio: 60% stocks and 40% bonds. A younger investor with decades until retirement might hold more stocks, while someone who needs the money soon might hold more bonds. There is no single correct mix; it depends on your goals, time horizon, and how much volatility you can tolerate.
It is worth noting that stocks and bonds do not always move in opposite directions. In 2022, for example, both fell at the same time as interest rates rose quickly. Diversification reduces risk, but it does not eliminate it.
How Beginners Usually Invest in Stocks and Bonds
Buying individual stocks and bonds requires research and a large enough portfolio to diversify. Many beginners instead use funds:
- Stock index funds or ETFs hold hundreds or thousands of companies in a single investment.
- Bond funds or ETFs hold many bonds with different issuers and maturities.
- Balanced or target-date funds hold both, and automatically keep a set mix.
Before choosing any fund, it helps to understand costs and structure. Our guide to evaluating ETFs covers what to look for.
Common Beginner Questions
Are bonds “safe”?
Bonds are generally less volatile than stocks, but they are not risk-free. Their prices can fall, especially when interest rates rise, and some issuers default.
Do I need bonds if I am young?
Some young investors with a long time horizon choose a high stock allocation. Others prefer some bonds to reduce volatility and help them stay invested during downturns. The right answer depends on your personal situation and risk tolerance.
Are dividends the same as bond interest?
No. Bond interest is a contractual obligation; dividends are paid at the company’s discretion and can be reduced or stopped at any time.
Key Takeaways
- A stock is ownership in a company; a bond is a loan to an issuer.
- Stocks have historically offered higher long-term growth with higher volatility; bonds usually offer steadier income with lower growth.
- Both carry risks – including market, credit, interest-rate, and inflation risk.
- Most portfolios combine the two, and the mix (asset allocation) is one of the most important investment decisions you will make.
Important Disclaimer
The information in this article is for general educational purposes only and does not constitute financial, investment, tax, or legal advice. All investing involves risk, including the possible loss of principal. Examples are simplified illustrations, not predictions. Consider consulting a qualified professional before making financial decisions. See our full Disclaimer.
