Stocks vs. Bonds - Understanding the Basics

Stocks vs. Bonds

Investor success is typically predicated on understanding some of the basic assets that can be owned as part of a financial portfolio. No discussion of financial investment is complete without understanding the basic differences between a stock and a bond. 

Stocks are traded on an equity exchange where individuals or organizations seek to purchase shares of organizations. Examples of equity exchange markets (i.e. stock market) in the United States are the NYSE and the NASDAQ. When purchasing a share of an organization, you essentially obtain a fraction of ownership interest in the organization which typically makes you eligible for voting rights within the company, as well as potential investment returns in the form of dividends and capital gains. Stocks can be purchased as individual shares or ETFs through the stock market. Stock ownership can also be obtained through investment into a mutual fund or an index fund, typically purchased through your investment firm.

Bonds are exchanged either over the counter or as part of a fund (ETF or index). In purchasing a bond, or a similar index or ETF fund, you are lending money to either a corporation or a government entity at a fixed or floating interest rate as determined at purchase. Practically speaking, by purchasing a bond you are lending money to one of these agencies similar to the way the bank lends money to a borrower. Essentially, you are the creditor in this relationship.

Similarities

First, let us point out clearly where stocks and bonds are similar:

• Both are forms of financial securities
• Both offer a way for organizations to raise money
• Many investors choose both in their portfolio, albeit in different ratios

Differences

Now, where do they differ:

• Stocks offer ownership interest in the company in exchange for your capital
• Bonds do not offer ownership, they enter a borrower relationship with you as the lender
• *Stocks have returned just over 10% since 1926
  • Best year (1933): 54.20%
  • Worst year (1931): –43.13%
  • Years with a loss: 26 of 94
• *Bonds have returned just over 5% per year since 1926 
  • Best year (1982): 32.62%
  • Worst year (1969): -8.13%
  • Years with a loss: 14 of 94
• Stocks are typically more volatile than bonds (highlighted above when comparing Worst years)
• Stockholders have voting rights and Bondholders do not
• Stocks typically purchased through the stock market (centralized market)
• Bonds typically purchased over the counter or through secondary bond market (no centralization of the market)

*According to Vanguard's Historical index risk/return (1926–2019)
**Note: Vanguard's Historical data for stock returns is primarily using one of the S&P indexes over time whereas fixed income (bonds) is highly varied between periods. See the bottom of their article for precise methodology.