Stocks and bonds are widely used financial instruments for investing. They differ in the variety of their issuers. Stocks are limited to public companies.Bonds include not just public companies but private companies, nonprofit organizations, and local, state and federal government entities. Most stocks are sold on exchanges, while bonds typically are available in over-the-counter trading.
Owner vs. Lender
A central difference between stocks and bonds is the role that investors play in relation to them. When investors purchase shares of a stock, they become shareholders and legal owners of the company. Therefore, stocks that are publicly traded are publicly owned.
In contrast, purchasing a bond makes you more of a lender than an owner. The issuer of the bond uses your money, and the money of other investors, to fund a project or other effort, paying you interest in return. At a set date, which is the bond's maturity date, the issuer repays investors their original investment.
Risk and Reward
Bonds are considered lower-risk, lower-reward investments than stocks, but both instruments carry a level of risk, and bonds sometimes outperform stocks overall for stretches.
Bonds' primary risk is default, which would mean the issuer of the bond would be unable to pay back interest and principal to investors. There's also the risk that interest rates will rise and the bond price will drop, reducing the value of the investment. Stock prices similarly are not guaranteed; stocks can produce modest of dramatic gains or losses.
Bonds and stocks both vary greatly within their fields. Some are considered high-risk investments, and others are viewed as more stable, conservative picks with reliable returns.
Both stocks and bonds can provide regular streams of income for investors. Bonds pay interest to their investors, typically in semiannual payments. Interest rates vary with the types of bonds and the level of risk of default. Bonds with higher risks of default offer higher levels of income. Through interest payments, bonds can preserve an investor's cash while still providing a steady source of new funds.
Stocks offer income through dividend payments, which are regular payments that stocks make from the profits of a company. However, not all stocks provide dividends. Some companies reinvest profits into their growth. More important to a stock investment is the growth of its share price.
Bonds carry definite dates when the bonds will mature and investors are due to receive a return of their principal investment. Bonds have a variety of lengths, so that investors have short-term, intermediate-term and long-term options to consider, ranging from fewer than three years to longer than 10 years.
Stocks do not carry end dates. Shares are purchased with an open-ended ownership, leaving it to investors to determine how long they want to hold the shares. There also is no date when investors can expect to receive their principal investment.
- Investing in Bonds: Why Invest in Bonds?
- "Making the Most of Your Money," Jane Bryant Quinn
- Bloomberg: Say What? In 30-year Race, Bonds Beat Stocks