By: Dennis Conklin

For new investors, understanding the different types of investment options can feel overwhelming. One common area of confusion is how stocks and bonds differ and how they can each play a role in an individual’s investment portfolio.

I recently spoke with Ramsey Brock, president of Brock Asset Management. As he explains, understanding the key differences between stocks and bonds and having a clearly defined investing strategy is crucial for allocating the right mix of these assets in one’s portfolio.

Stock Basics

Buying a stock means you have equity or partial ownership of a company. As you purchase more shares, you own more of the company. The value of your shares grows or falls in line with the company’s value — and when you decide to sell your shares, you either gain or lose money based on how the current value compares to the value when you first bought them.

Brock explains, “Individual stocks vary in risk profile and potential for generating a positive return. Many factors influence whether a stock will increase or decrease in value, such as the company’s performance, underlying market strength, and even world events that influence its niche or business. Investing in individual stocks tends to have higher risk, but this also has the potential for higher returns.”

Historically, the average annual return of the S&P 500 is around 10%, though that can vary significantly between individual stocks. Brock points out that investors only make money when they sell their stocks and that stocks are liable to capital gains tax when they are sold at a profit.

How Do Bonds Work?

Bonds aren’t investments in the same sense that stock is. Instead, a bond is a type of loan that you provide to the government or a company. A bond essentially gives them a loan, which the government or company you bought from is then required to pay interest on for the bond period. Interest rates tend to be lower than growth achieved through stocks, with treasury bonds offering 4.5% interest on 30-year bonds.

Treasury bonds issued by the U.S. government are the most well-known. Issued for terms of 20 to 30 years, the government makes fixed interest payments to bondholders every six months until the bond matures. When the bond matures, the government pays back the initial investment amount. Corporate bonds work similarly, though interest payment timelines can vary. It’s also worth noting that corporate bonds carry some risk if the company that issued them were to go bankrupt.

“Bonds are a much lower-risk investment than stocks, particularly if you obtain a bond through the government. The interest payments from bonds act as a fixed income, making them an attractive option for conservative investors,” Brock says.

“Bonds can also be more attractive in some cases because treasury bond interest payments are often exempt from state income tax, and municipal bond interest payments are exempt from federal income tax and often exempt from state income tax.”

Picking the Right Options for Your Investment Needs

Brock feels that understanding how stocks and bonds work and the likely risk and return is essential for developing an investment portfolio that caters to your unique needs.

“Deciding which stocks and bonds to invest in should be heavily influenced by your risk tolerance and overall investing goals,” he explains. “Long-term, you will likely see better returns from investing primarily in stocks. If you prefer a more predictable income stream and lower risk to your initial investment, bonds may align better with your investment approach. Incorporating both types of assets can help create a diversified portfolio tailored to managing risk.”

As part of this, Brock recommends that an investor’s portfolio balance be adapted over time based on proximity to a particular financial goal. “Generally speaking, your investment mix should become more conservative as you get closer to a financial goal such as retirement,” he explains.

“So, when you start investing, your portfolio would lean more heavily toward stocks while only incorporating a smaller percentage of bonds. As you get closer to your target date, that balance shifts until you allocate more to bonds than stocks. This might give you greater opportunity for growth early on while offering greater protection against market downturns right before you reach your goal.”

Making the Right Choice

As Brock’s comments help illustrate, there isn’t necessarily a one-size-fits-all answer for whether stocks, bonds, or a mixture of both assets is best for your portfolio. It largely comes down to your risk tolerance and investing goals. And, of course, you will also need to evaluate the potential risk and reward associated with individual stocks and bonds.

By doing your due diligence and ensuring that your investment decisions align with your financial goals, you can put yourself on track to reach them. Don’t hesitate to consult a financial professional to determine what type of portfolio balance will fit your long-term strategy.

Disclaimer: This content is for informational purposes only and is not intended as financial advice, nor does it replace professional financial advice, investment advice, or any other type of advice. You should seek the advice of a qualified financial advisor or other professional before making any financial decisions.

Published by: Annie P.