Pros & Cons of Stocks Vs. Bonds
Investors choose stocks in hopes of growing the original size of an investment as companies increase their profits. Stock prices are vulnerable, however, to changes in a company's financial health, the economy and broader stock market trends, all of which place investors at risk of losing money. Bond investors generally seek protection for their assets while earning slight returns. Investing in bonds alone, however, does not generally produce the types of returns that are needed for major financial milestones, such as saving for college or retirement.
Economic conditions can help or hurt the prospects for both stocks and bonds. When an economy is growing at a reasonable pace, companies have a fair chance to increase profits, thereby providing an incentive for investors to buy the stock. In a slowing economy, corporate profits can be compromised, which can in turn cause the market values of stocks to falter. Bond investors can generally count on a dependable income stream from stable bond issuers. Nonetheless, fixed-income investors run the risk of rising inflation, which diminishes the buying power of a currency and compromises the value of their steady income, according to an article on the Bloomberg website.
On the surface, investment volatility, which is when the markets exhibit severe and seemingly unwarranted price swings, is more a characteristic of equities. Stocks are typically the more volatile of the two asset classes, and as a result are deemed riskier than bonds. High-yielding bonds, however, which have attractive interest rates compared with traditional bonds but are at a greater risk of default, exhibit market volatility that is more comparable to stocks than their U.S. Treasury counterparts, according to an article on the CBS Money Watch website. Unlike Treasuries and investment-grade bonds, high-yield bonds do not provide the usual protection from equity price swings.
Stocks are often attractive because of their potential returns while bonds are used to shield an investment portfolio from losses. These asset classes do not always perform as expected, however. Over the 10-year period beginning in 2002, for instance, bond returns exceeded stock market profits by some 5 percent, according to ABC News. Nonetheless, investors can identify pockets of strength within equities. Over the longer term, the largest, industry-leading equities produce average returns of 10 percent each year, based on data collected from the mid-1920s and cited on the CNN Money website.
Bankruptcy is a risk for investors in stocks and bonds. If a company files for Chapter 11 bankruptcy protection, shareholders become at risk of losing the face value of their original investment. Investors are considered for repayment only once creditors, such as suppliers, are repaid. If there are any remaining assets, bond investors, a type of creditor, are paid next. Equity investors are last in line to be repaid, and — based on data from corporate restructurings that occurred in 2009 and 2010 — have about a 1-in-10 chance of being repaid, according to a UCLA School of Law study cited in an article on the "Business Week" website.
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.