Stocks vs. Bonds: How the Two Main Investments Differ
Stocks buy a share of a company; bonds lend money to a government or a company. Here is how each works, what each costs, and which fits different goals.
Stocks and bonds sit side by side in most retirement accounts, and both are bought through a brokerage account. That shared shelf space is part of why people mix them up. The two work in opposite ways: a stock buys a small piece of a company, while a bond lends money to a company or a government.
How stocks work
A stock is a share of ownership in a public company. When the company earns more money, grows, or pays a dividend, shareholders can benefit. When earnings fall or the market drops, the share price can fall, sometimes by a large amount in a short time.
Stockholders can earn money in two ways: the share price rises and they sell for more than they paid, or the company pays part of its profits to shareholders as dividends. Dividends are not promised. A company can cut or stop them at any time.
Stock prices move every second the market is open. Over long stretches, stocks have returned more than bonds on average, but they have also fallen further in bad years. In 2008, the broad U.S. stock market fell by more than a third. That is the trade: higher long-run gains in exchange for bigger swings.
How bonds work
A bond is a loan. The buyer lends money to a borrower, the federal government, a state or city, or a company, and the borrower pays interest at set dates and returns the full amount, called the principal, when the bond matures.
The interest payments, called coupon payments, are usually fixed. That makes bonds steadier than stocks: the income arrives on a schedule, and the principal comes back at maturity if the borrower stays able to pay.
The main risks are different from stocks. If interest rates rise, older bonds paying lower rates lose value when sold before maturity. If the borrower runs into trouble, payments can stop. U.S. Treasury bonds carry the backing of the federal government and are treated as the safest bonds in the country. Corporate bonds pay higher interest because the risk of default is higher. Bond prices and yields change daily, so any yield figure quoted today is only a snapshot.
Stocks vs. bonds at a glance
| Stocks | Bonds | |
|---|---|---|
| What it is | A share of ownership in a company | A loan to a government or company |
| Who it fits | Investors with a long time horizon who can ride out price drops | Investors who want set income payments and smaller price swings |
| Costs | Most large U.S. brokerages charge no commission on stock trades; stock funds charge an annual expense ratio | Bonds bought through a broker can carry a markup; bond funds charge an annual expense ratio |
| Pros | Higher long-run returns on average; dividends and growth potential | Set interest payments; principal returned at maturity; smaller price swings |
| Cons | Prices can fall sharply; dividends are not promised | Returns are usually lower; rising rates cut the value of older bonds; the borrower can default |
Verdict: which one fits your goal
Choose stocks if you have years before you need the money and can accept a year when your balance drops. A worker in their 30s saving for retirement is the usual case: time smooths out the drops, and the higher long-run return matters more than the swings along the way.
Choose bonds if you need the money soon or cannot accept a large drop. A retiree drawing income from savings, or someone saving for a house deposit in two years, is the usual case: set interest payments and the return of principal at maturity matter more than growth.
Most investors hold both. A common pattern is to hold more stocks when young and shift toward bonds as the date the money is needed draws near. The exact mix is a personal choice that turns on age, income, and how much loss a person can stand without selling.
Explainer based on investor education material published by the U.S. Securities and Exchange Commission and the U.S. Department of the Treasury.
