Investing builds wealth for your long-term goals and financial security. As you begin to explore your options, it’s essential to establish your financial goals and objectives and identify the types of investments to help you achieve them. For instance, two of the most common types of investments are stocks and bonds, but what’s the difference between them? Which type is more likely to help you achieve your long-term financial goals?
Stocks vs. Bonds: What’s the Difference?
Stocks are shares in a company.
When you purchase stock, you become a shareholder in the ownership of the business. You have a voting right in the company’s management decisions. As the company grows, so does your investment.
Bonds are a loan to the government or company that issues them.
When you purchase bonds, you are, in essence, a lender. Each bond is set at a specified value and comes with a maturation date. When the bond matures, the issuer repays the original amount you loaned. In the interim, the company or government pays you interest annually or bi-annually.
Stocks are riskier, but you have the potential to make a windfall profit in the short term if all goes well with the economy or industry. On the other hand, you also run the risk of losing everything you invested.
Bonds are safer, and most are less vulnerable to disruptions in the economy. But the return on the investment is lower. However, except in unusual circumstances, you’ll receive the total amount of the principal you invested.
Stocks vs. Bonds: Which Should You Choose?
As mentioned above, when you purchase stock in a company, you become a shareholder. You have the right to vote on select company management decisions, such as the board of directors.
The company distributes dividends annually or according to some other schedule. The amount you receive is based on the number of shares you own and the company’s performance. But, a distribution schedule is not fixed, and the company can delay or offer additional shares rather than money when the cash flow is tight.
If the company goes bankrupt, you lose your investment. Upon liquidation of the company’s assets, you are the last creditor to be paid.
As a bondholder, you do not have any ownership in the government or corporate entity that issued the bonds, nor do you play a role in project management decisions.
Companies or governments that issue bonds are obligated to make regular payments to their bondholders according to the terms of the bonds. In the most severe circumstances, the issuer may delay an interest payment. But this step is rarely taken, as it lowers the bond rating, impacting future investor interest.
Unlike shareholders, however, if the issuing entity collapses, bondholders are given priority over other creditors when the assets are liquidated.
The Risk of Investing in Stocks vs. Bonds
Investing in stocks is riskier because so many variables are at stake in addition to the company’s performance. The recent pandemic forced many companies into foreclosure. But it also boosted the revenues of others.
Investing in bonds is less risky, but it depends on the issuer. Government bonds, for instance, are considered safe. Theoretically, bonds offer a guarantee of your initial investment, even if the annual interest payments are not what you expected.
Stocks vs. bonds? Ultimately, it depends on your financial goals and ability to tolerate risk.
- If you’re risk-averse, you might want to look into purchasing long-term bonds from a reputable financial entity.
- If you enjoy the stock market and are looking for short-term gains, you might prefer to invest in stocks. Buying shares in growing companies could net you significant returns over the long term.
- Financial advisors recommend creating an investment portfolio that includes a healthy mix of stocks, bonds, and other investment types.
- In all cases, doing your homework before jumping in is imperative.