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Summary
- Both stocks and bonds are popular financial instruments.
- While bonds are more suitable for risk-averse investors, stocks come with higher risk and offer relatively high returns.
- Both have their own advantages and disadvantages.
Both stocks and bonds are popular forms of investments. While bonds generally offer reliable returns to risk-averse investors, stocks give relatively high returns but with greater risk. However, the two financial instruments have their own advantages and disadvantages.
Investors should carefully understand the distinguishing factors since these asset classes have different features, payout ratios and risks.
Here, we would have a look at the pros and cons of bonds and stocks so that an individual can have a right mix of these two forms of investments in his portfolio, based on his age, investment goals and risk tolerance.
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First, let us understand in short what we mean by stocks and bonds.
Stocks
Holding a particular company's shares makes you the shareholder of that company and gives you voting rights. You also get dividends from the company as and when it decides to do so.
However, stocks also come with a risk of fall in value, which may even dip to zero in some cases. Thus, the profitability of the investment depends on fluctuations in stock prices, which are fundamentally related to the company’s growth and profitability.
READ MORE: Top five renewable energy stocks on ASX
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Bonds
A bond is a fixed income instrument which pays a fixed interest rate to debtholders. This financial instrument comes with a maturity date at which the principal amount is paid back to the bond holder. The bond prices are inversely correlated with interest rates.
There are bonds that may carry the risk of default, where an investor may lose his entire investment. Such debt is rated below investment grade, and referred to as high-yield bonds, non-investment-grade bonds, speculative-grade bonds, or junk bonds.
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Stocks or bonds?
The pros of buying stocks instead of bonds is that the equities have an inherent ability to give higher returns. Thus, the investors with higher risk-taking capacity can be better off choosing stocks. Investors can also consider dividend stocks to get steady returns.
The disadvantage is that equities are riskier than bonds. Stocks offer no guaranteed returns unlike bonds, which offer reliable returns.
The risk-averse investors should, hence, consider more structured payout schedules and would be better off investing in bonds.
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