Buying Stocks Instead of Bonds: Pros and Cons (2024)

Stocks and bonds each possess their own sets of advantages and disadvantages. Furthermore, each asset class features dramatically different structures, payouts, returns, and risks. Understanding the distinguishing factors that separate these two asset classes is key to building a healthy investment portfolio that thrives over the long haul.

Of course, asset allocation mixes are unique to each individual, based on an investor's age, risk tolerance, and long-term investment and retirement goals.

Key Takeaways

  • Stocks offer the potential for higher returns than bonds but also come with higher risks.
  • Bonds generally offer fairly reliable returns and are better suited for risk-averse investors.
  • For most investors, diversifying portfolios with a combination of stocks and bonds is the best path toward achieving risk-mitigated investment returns.

Buying Stocks Instead of Bonds: An Overview

Stocks are essentially ownership stakes in publicly-traded corporations that give investors an opportunity to participate in a company's growth. But these investments also carry the potential of declining in value, where they may even drop to zero. In either scenario, the profitability of the investment depends almost entirely on fluctuations in stock prices, which are fundamentally tied to the growth and profitability of the company.

A bond is a fixed income instrument that represents a loan made by investors (known as "creditors" or "debtholders") to borrowers, which are typically corporations or governmental entities. Also known as coupons, bonds are characterized by the fact that the ultimate payouts are guaranteed by the borrower. With these investments, there is a concrete maturity date, upon which the principal is repaid to investors, along with interest payments attached to the interest rate that existed at the onset of the loan.

Bonds are used by corporations, states, municipalities, and sovereign governments to finance a multitude of projects and operations. That said, some bonds do carry the risk of default, where it is indeed possible for an investor to lose his or her money. Such bonds are rated below investment grade, and are referred to as high-yield bonds, non-investment-grade bonds, speculative-grade bonds, or junk bonds. Nevertheless, they attract a subset of fixed income investors that enjoy the prospect of higher yields.

Pros of Buying Stocks Instead of Bonds

The chief advantage stocks have over bonds, is their ability to generate higher returns. Consequently, investors who are willing to take on greater risks in exchange for the potential to benefit from rising stock prices would be better off choosing stocks.

Investors may also wish to consider investing in dividend-paying stocks. A dividend is essentially a distribution of some of the profits that a corporation makes to its shareholders. And any dividends that are not taken may be re-invested in the businessin the form of more shares in a company.

Bonds also pay regular income in the form of interest payments; however, these cannot be reinvested back into the same bond. Interest rates can change over the life of the bond, which creates reinvestment risk, or the risk that new bonds will have lower yields than the ones you are receiving interest from.

Diversifying investments across both stocks and bonds, marries the relative safety of the bonds, with the higher return potential of stocks.

Cons of Buying Stocks Instead of Bonds

In general, stocks are riskier than bonds, simply due to the fact that they offer no guaranteed returns to the investor, unlike bonds, which offer fairly reliable returns through coupon payments. Stocks are inherently more volatile than bonds because in the event of a corporate bankruptcy, bondholders (who are a company's creditors) have priority in being repaid. Meanwhile, owners of common stock are last in line, and can end up with nothing if the company goes bankrupt.

Risk-averse investors looking to safely deploy their capital and take comfort in more structured payout schedules would be better off investing in bonds.

Have Stocks or Bonds Performed Better Historically?

The historical returns for stocks have been between 8%-10% since 1928. The historical returns for bonds have been lower, between 4%-6% since 1928. Over the past 30 years, stocks have returned an average of 11% annually; while bonds have returned just 5.6% per year, on average.

How Much of My Portfolio Should Be in Stocks?

A well-diversified portfolio contains a broad range of holdings across several asset classes. In general, the longer your time horizon (i.e., the younger you are), the more risk you can take on. Therefore a portfolio weighted 80-90% in stocks and the rest in bonds or other assets is bearable. However, as your time horizon shortens, it is recommended to shift your allocation increasingly toward lower-risk bonds and reduce your allocation to stocks.

Why Do Stocks Generally Outperform Bonds Over Time?

Stocks generally outperform bonds over time due to the equity risk premium that investors enjoy over bonds. This is an amount that investors of stocks demand in return for taking on the additional risk associated with stocks. Stocks also benefit from a growing economy. As GDP grows, so too do corporate profits, which are reflected in the prices of stocks, but not typically in bonds (which are essentially loans).

Buying Stocks Instead of Bonds: Pros and Cons (2024)


Buying Stocks Instead of Bonds: Pros and Cons? ›

Pros and Cons – Bonds vs Stocks

What are the pros of buying stocks instead of bonds? ›

Key Takeaways. Stocks offer the potential for higher returns than bonds but also come with higher risks. Bonds generally offer fairly reliable returns and are better suited for risk-averse investors.

What are the pros and cons of buying stocks? ›

Investing in stocks offers the potential for substantial returns, income through dividends and portfolio diversification. However, it also comes with risks, including market volatility, tax bills as well as the need for time and expertise.

Are stocks safer than bonds? ›

Given the numerous reasons a company's business can decline, stocks are typically riskier than bonds. However, with that higher risk can come higher returns.

Should I move money from stocks to bonds? ›

Shifting more of a portfolio's allocation to bonds and cash investments may offer a sense of security for investors who are heavily invested in stocks when a period of extended volatility sets in. That can be a key component of trying to protect your 401(k) from a stock market crash.

What are the cons of investing in stocks? ›

Disadvantages of Investing in Stocks

Stock markets are known for their unpredictability. Prices can fluctuate rapidly, influenced by a myriad of factors such as economic events, company performance or global crises. This volatility can be nerve-wracking for investors, especially those with a low risk tolerance.

How much should I invest in stocks vs bonds? ›

The rule of thumb advisors have traditionally urged investors to use, in terms of the percentage of stocks an investor should have in their portfolio; this equation suggests, for example, that a 30-year-old would hold 70% in stocks and 30% in bonds, while a 60-year-old would have 40% in stocks and 60% in bonds.

Is it really worth investing in stock? ›

Investing in stocks is definitely a good way to grow your wealth over the long term, but it comes with risks. Here are some points to consider: Risk Tolerance: Understand your risk tolerance. Stocks can be volatile, and their value can fluctuate significantly in the short term.

Is it still a good idea to invest in stocks? ›

Because investing is a long-term strategy, there really isn't a bad time to invest. In fact, bear markets can actually be fantastic investing opportunities because prices are lower.

What is the downside to bonds? ›

Historically, bonds have provided lower long-term returns than stocks. Bond prices fall when interest rates go up. Long-term bonds, especially, suffer from price fluctuations as interest rates rise and fall.

Should I invest in stocks or bonds 2024? ›

Long-term bonds have an average maturity of 10 years or longer, making them a better choice when interest rates are falling, as they're expected to do in 2024.

Why buy bonds and not stocks? ›

Stocks offer ownership and dividends, volatile short-term but driven by long-term earnings growth. Bonds provide stable income, crucial for wealth protection, especially as financial goals approach, balancing diversified portfolios.

Do stocks outperform bonds? ›

Individual stocks may outperform bonds by a significant margin, but they are also at a much higher risk of loss. Bonds will always be less volatile on average than stocks because more is known and certain about their income flow.

What is the best investment right now? ›

11 best investments right now
  • Money market funds.
  • Mutual funds.
  • Index Funds.
  • Exchange-traded funds.
  • Stocks.
  • Alternative investments.
  • Cryptocurrencies.
  • Real estate.
Mar 19, 2024

Should I buy bonds when interest rates are high? ›

Should I only buy bonds when interest rates are high? There are advantages to purchasing bonds after interest rates have risen. Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels.

How much of 401k should be in stocks? ›

Traditional guidance is that the percentage of your money invested in stocks should equal 100 minus your age. More recently, that figure has been revised to 110 or even 120 because the average life expectancy has increased.

What is the benefits of investing in stocks? ›

Benefits Of Investing In Stocks
  • Smooth and Continuous Transactions.
  • Diversification.
  • Dividend Benefits.
  • Investment Gains.
  • Liquidity.
  • Higher Returns over the Short Term.
  • They are well protected by SEBI.
  • Flexibility To Invest in Smaller Amounts.

Why do stocks outperform bonds? ›

The best that statistics can do is to say we are 95 percent certain that the true average excess return is between 3 percent and 13 percent. Why do stocks outperform bonds? The obvious answer is that stocks are riskier than bonds, and investors are risk averse and thus demand a higher return when they buy stocks.

What are the pros and cons of issuing bonds? ›

Bonds have some advantages over stocks, including relatively low volatility, high liquidity, legal protection, and various term structures. However, bonds are subject to interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk.

Why should you invest in stocks? ›

The potential benefits of investing in stocks include: Potential capital gains from owning a stock that grows in value over time. Potential income from dividends paid by the company. Lower tax rates on long-term capital gains.

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