Stocks, or equities, are little slivers of a company. When you buy a stock, you’re technically become a part owner in that business. As the valuation of the business increases so does the value of your share. You can trade that share to someone else or buy more shares. A company that pays dividends is letting stock owners share in their profits.
Bonds represent a unit of debt – or money that’s been lent to either a company or government. You don’t own any of that company or a piece of the government, but since you own some of their debt, they technically owe you money. Bonds include a fixed interest on that debt and a specific term of repayment of the principal, which is frequently referred to as the face value.
With stocks you’re buying a piece of the business. With bonds you’re essentially owning a tradeable unit of business or government debt.
The Similarities Between Stocks and Bonds
There’s a reason both terms are often used in quick succession. The way in which stocks and bonds are traded are fairly similar. Anyone can easily open an investment account through which they can purchase and sell stocks and bonds. Many retirement savings vehicles, like 401(k)s or IRAs, allow you to purchase stocks and bonds.
Some mutual funds and ETFs hold both stocks and bonds (often referred to as “hybrid funds”), so you could technically be getting both small ownership interests in some companies and a small bit of debt through one purchase.
And they both serve the same fundamental purpose as investment tools that can be used to grow and protect your money. Equities have a much greater potential for growth but also far more risk. A company’s valuation can increase dramatically due to a new product, service or patent. Bonds, especially treasury bonds (treasuries) or municipal bonds, tend to be far lower risk since they are backed by the U.S. government or a municipality.
Although bonds may not be risky, there’s also not a lot of reward. You get a little bit of interest on the debt you own and a guarantee that you’ll be paid the principal. You know exactly what you’re getting at the end of the term when you buy the bond. Stocks are very different. Some companies might crash and burn while others grow exponentially. They’re never guaranteed.
Is There a Difference Between Stock, Shares and Equities?
Not in the way the terms are frequently used in modern parlance.
The idea of equity – like the equity in your home – and equities as stock are essentially the same concept. The equity you have in your home is the value that you own. If your home is valued at $300,000 and you still owe $100,000 on your mortgage you have $200,000 of equity.
From a financial standpoint you don’t really own your entire home until it’s totally paid off, just like when you buy a share of stock you don’t own the entire company – you just have some equity.
What’s Better – Stocks or Bonds?
The answer is a judgement call.
Even the greatest bond advocates will admit the chance for hitting it big is non-existent with bonds, but they are one of the safest investments. Investing in bonds may be an effective way to insulate your portfolio from market volatility, downturns or crashes. Some people who are retiring or are about to retire begin reallocating their assets into bonds to minimize their risk.
However, not all bonds are inflation proof. Equities are usually a better way to protect your money from inflation since the market tends to do better during periods of high inflation. High-dividend stocks might decline temporarily, and markets can become more volatile, but valuations tend to rise to keep pace with the dollar’s buying power.
Bonds are generally static. The terms, rate and principal on a 10-year treasury note remains static regardless of inflation or deflation during that 10-year period.
There are Treasury Inflation-Protected Securities (TIPS) that are designed to protect against inflation. The principal of a TIPS bond is adjusted based on inflation as measured by the Consumer Price Index (CPI). You are either paid the adjusted principal or the original principal depending on whether there’s been inflation or deflation (you’ll always be paid the larger of the two).
That doesn’t mean TIPS are risk free. The Treasury sets a floor on TIPS value but there are scenarios in which deflation causes traditional treasury bonds to outperform TIPS.
Which to Choose: Stocks or Bonds?
The choices you make about your retirement savings are uniquely personal and should be based on factors like the size of your nest egg, personal risk tolerances and the lifestyle you envision. The right investment portfolio for one retiree might be completely different from another.
The certified fiduciaries at Fullerton Financial Planning in Phoenix and Tempe have dedicated their careers to giving honest, transparent advice on retirement planning and investment management. Your best interest is always our highest priority. Give our team a call at (623) 974-0300 to learn about your options.
