Stocks versus Bonds – Which are right for me?

Stocks versus bonds, are you unsure which direction to take? Let’s take a look a the key advantages and disadvantages.

You own part of the company with stocks

With you buy stocks, you are purchasing a portion of the company. If you only buy a few shares, the portion might be very small. Nevertheless, you still own part of the company.

When you buy bonds, you never own a part of the money, you are effectively lending money to the company.

Dividends

A big difference when it comes to stocks vs bonds is bond holders are not entitled to a dividend, where shareholders are if one is paid.

Pricing

Stock prices fluctuate all the time. The fundamentals of a company and speculators affect the prices.

The price of bonds fluctuates in line with base interest rates. I’ll explain why. If you have a bond with a company that is paying you 3% per year and the base rate goes appreciably, the price of the bond will be likely to lower because the nobody is going to buy your bond at face value if they can get a higher risk-free return elseware.

Market Fluctuations

I am sure you know how wildly the stock market can fluctuate. Swings of 10% in a month have occurred on many occasions over the years.

Bond prices tend to be much more stable, unless there is a massive change in the base rate or a company there is a risk a company may default some or all of payment.

Maturity Dates

Stocks can be bought and sold at anytime, providing there is sufficient liquidity.

However, bonds have maturity dates. Think of it like a convention loan, it will eventually get paid off.

Company Performance

If a company performs really well one year, it is highly likely this will be reflected in a higher dividend, especially if it is a blue chip stock.

However, with bonds the performance of a company isn’t as important, as you will still get the same rate of return regardless of how much profit the company makes. The only time performance makes a difference is if the company gets into financial difficulties, there is the risk they may default on part of all of the bond.

Assessing risk

When assessing the of stocks, many factors can be used including:

  • The age of the company
  • Profit history
  • Sector competition
  • Market share trends
  • Financial ratios like Earnings per share (EPS), Price/Earnings ratio (P/E ratio)
  • When it comes to assessing the risk of a bond it works a little differently. Unlike stocks where you primary goal is for the stock to increase in value and receive dividends. The main concern for bond holders is that the company is going to have the money to honor them.

    There are various companies out there who offer information on the credit ratings of bonds. The most respect ones are S&P and Moody’s.

    So Stocks versus Bonds. Which is best?

    Stocks vs bonds, it can be a tricky one for some. There are many factors to consider.

    If you wish to invest short term and are happy with lower returns for a lower risk, then highly rated bonds are probably your best option. The best choices are most likely to be government bonds or bonds in blue chip companies.

    If you want to grow your money over a long period of time (at least five years), then stocks may be a better choice. In the long term, the stock market has outpaced bonds by quite a margin. Of course, even in the long term, timing can be a big factor. My article on long term investing looks at this in more detail.

    There is nothing stopping you from having part of your portfolio in bonds and part in stocks. In fact this is quite a common investment strategy.