Stocks and bonds are in non-correlated asset classes, which means that under stable economic conditions, they gain and lose value based on separate sets of factors. As a result, the risks associated with a bond portfolio are quite different from those of a fund filled with stocks. The profits vary, too. Investors traditionally look to stocks for the highest profit, and to bonds to protect an initial investment.
Traditional bonds, including government Treasuries and highly rated corporate debt securities, lend stability to an investment portfolio. Unlike high-yield bonds, which promise attractive returns but have low credit ratings, traditional bonds are not likely to default and leave investors with nothing. Stocks can be grouped by size, which is measured by market capitalization ranging from small cap to large cap, or by their growth potential, which is an indication of future profits. Larger companies are a reliable introduction to a stock portfolio, but their prices don't have as much room to advance in comparison with the stocks of smaller companies, according to a 2010 article on the CNBC website.
A stock portfolio is likely to exhibit greater volatility, or erratic price movements, than bonds. In the near term stocks can be especially volatile, responding to economic conditions and corporate profits as well as to events, including clinical trials and new product pipelines. Bonds are deemed a safe haven from stocks, especially during times of economic uncertainty. Nonetheless, bonds pose risks of their own. In 2012, when corporate-bond interest rates bottomed at record levels, investors were withdrawing money from stock mutual funds and directing it into bond portfolios. Those investors ran the risk of owning debt securities even as rates eventually reversed course, which would compromise the value of their investments, according to a 2012 article on the Barron's website.
Dividend stocks make quarterly or yearly payments that can resemble the income earned from bonds. Indeed, when the interest-rate environment is low and investors are earning only mediocre returns from bonds, they are increasingly turning to dividend stock funds to compensate, according to a 2012 article in "The Wall Street Journal." Nonetheless, investors face a greater chance of market losses from dividend stocks than from bonds. In August 2011, when the European economy was faltering, U.S. bond funds advanced more than 1 percent, while a stock dividend portfolio lost nearly 5 percent .
Whether an investor is building a bond or stock portfolio, the portfolio should be diversified. In a bond fund, this means investing across at least 20 individual bonds, including a mix of U.S. Treasuries, municipal and corporate debt securities, according to a 2011 article on the Kiplinger website. For stocks, diversification involves investing in stocks with both large- and small-market capitalizations. It also means buying both U.S. and overseas stocks, devoting as much as one-fifth of equity exposure to international equities, according to a 2009 "USA Today" article.
Video of the Day
- The Wall Street Journal: Why Dividend Stocks Aren't the New Bonds
- Kiplinger: If Interest Rates Rise, Bonds Or Bond Funds?
- USA Today: Diversification Eases Stock Losses But Can't Stop Them
- Barron's: Bernanke Has "Set A Trap" for Bond Investors when Rates RisW
- CNBC: Small Caps vs. Large Caps -- Where to Invest Now
- Finance image by Stephen VanHorn from Fotolia.com