Whether you have a strong existing portfolio or are looking to invest for the first time, understanding the difference between stocks and bonds can be a crucial bit of wisdom in your arsenal of financial knowledge. And while the distinction is significant, it fortunately doesn’t require an MBA to master. Read on for a simple, straightforward look at stocks vs. bonds regarding what they are, how they work, and overall investment strategy. Then, shop a handful of our favorite books for a deeper look at how to start investing.
Stocks vs Bonds: What Are They?
Simply put, stocks represent a share of a particular company. This means that when the company makes a profit, you receive a portion or share of that profit. On the other hand, it also means that you share in a company’s losses should its success experience a downturn.
Bonds, on the other hand, represent a pledge to repay a certain investment amount, with interest, at a certain point in the future. When you purchase a bond, you’re essentially behaving as a lender, and the company agrees to repay the debt at a specified date.
How Do Stocks & Bonds Behave Differently?
Beyond their intrinsic definitions, one of the primary factors distinguishing stocks vs. bonds is how they function in the marketplace. In general, stocks are considered to be riskier and less stable, though they also have the potential to yield a higher return as part of a carefully constructed investment portfolio. Bonds, on the other hand, are considered to be relatively predictable, based on the interest rates set forth at the time of purchase.
Just as it’s important to study fluctuations in the overall economy and stock market when considering investing in stocks, it’s also crucial to understand the quality of a particular bond.
Which Is Better for Investing?
Since stocks and bonds function differently when it comes to performance and risk, the best course of action is to diversify your portfolio with a combination of both stocks and bonds. Putting all your eggs strictly in one basket or the other can either yield a precarious group of investments or an underwhelming return. Arming yourself with a diverse array of investments—and a bit of key financial knowledge—can pay off dividends in the long run.
Bogle's The Little Book of Common Sense Investing is an excellent guide to investing for beginners.
If you'd rather opt for a more stable investment, Richelson's guide to bonds is a good starting place to learn more.
Cagan's Investing 101 goes beyond just stocks and bonds. Learn more about ETFs and IPOs to build a robust financial portfolio.
If you'd like to learn how to spot undervalued stocks, Graham's guide to value investing is a great starting point.
If you're less interested in investing in bonds, Kelly's guide to the stock market provides great advice for beginners.
Now that you know the difference between stocks and bonds, here’s a simple guide to the major types of investments.