Understanding stocks & bonds: the building blocks of a balanced portfolio.

Invest

Close up of a person holding a smart phone with stock information on the screen

Stocks and bonds are possibly the most common terms people use when they talk about investing. Rightly so, as they’re both crucial parts to every investor’s portfolio.

What’s the difference between the two?

A stock amounts to a piece of ownership in a company.

You may also hear stocks referred to as equity or shares. If someone says they own 500 shares of Facebook, they mean they own 500 very small pieces of Facebook. Companies issue stock to the public and that stock trades (is bought and sold) between investors on exchanges, like the New York Stock Exchange.

Stocks/equities can generate returns through capital gains or dividends. However, there is not a defined holding period or a promise of return of capital at the end of that period. Translation: stocks are fluid. Their values fluctuate up and down. There are no guarantees of gains — no matter what your best friend or coworker tells you.

A bond, on the other hand, is like a loan.

When you buy/invest in a bond, you are actually lending money to an entity with the promise that you’ll receive that money back, with interest, after a certain amount of time. The time-period can vary anywhere from one day to ten plus years, and the interest earned will vary bond to bond.

Bonds generate returns through periodic interest payments and with the principal amount returned to the lender at the end of the period. However, it’s important to note that bond prices may fluctuate during that holding period and can be sold for a gain or loss prior to your term ending.

Risk vs. reward

The greatest difference between stocks and bonds are their risk levels and their return potential. Speaking very generally, stocks have historically offered higher returns than bonds but also come with increased risk. While you may earn more with stocks, you may also stand to lose more.

That said, not all stocks have the same level of risk, and not all bonds are safe from fluctuations. A common misconception with stocks is that they all have equal levels of risk and that no other vehicle is riskier. And while generally speaking, stocks experience more market variance, high yield and emerging market bonds can carry more risk than some equities.

The bottom line is there’s no one magical investment that will never lose money, or one that will always make money. That’s why a portfolio that has a mix of both is beneficial for your finances.

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“The greatest difference between stocks and bonds are their risk levels and their return potential.”

So, what’s the right mix of stocks vs. bonds?

Too much of anything can become a bad thing. It’s essential to have a mix of stocks and bonds in a healthy investment portfolio. Since they each behave differently, a combination of both can provide a more balanced portfolio.

But the “right mix” really depends upon each individual investor’s risk tolerance, timeline, and strategy.

For example, if you’re 25 and saving for retirement that is 40+ years away, you can probably afford to take on more risk (and thus buy more stocks than bonds) than someone who is saving for a down payment on a home in 3 years or someone who’s looking to retire in 10 years or less.

As you age and get closer to pulling money out of your investments, you may focus less on growth and want the lower risk and potential for fixed income that bonds can generate.

If you need more personal help or guidance, you can always reach out to a professional Financial Advisor: someone to look at your portfolio and make sure it’s working for and towards your goals. It can be a onetime consultation or an ongoing working relationship to help you plan your overall investment strategy.

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