What is the Difference between Stocks and Bonds?

Among the most common securities that mutual funds invest in are stocks and bonds. Both have an important place in investors’ portfolios, so it’s important to understand what they are and how they differ.

Stocks Represent Ownership
When investing in a stock, the investor owns shares in a publicly-traded company. Therefore, each share of stock represents ownership. As part owners in a public company, investors participate in that company’s financial growth.

Shares are typically traded on an exchange, such as the New York Stock Exchange or the Nasdaq. Simply put, when the stock price rises, investors’ shares increase in value. When the price declines, investors’ shares decrease in value.

Because shares of public companies are traded in an open market, many investors have the ability to buy and sell their shares on any given trading day. Therefore, the price of your shares is not only subject to the financial well-being of a company but may also be subject to market swings that have little to do with the company’s actual value.

In general, stocks have historically provided higher returns and greater risk compared to bonds.

Bonds Represent Debt
Bonds are debt instruments of a corporation or government entity, an “IOU” or a loan generally with pre-set interest rates regularly paid to the investor for a specified amount of time. Typically, the investment has the backing of the company to pay back the principal amount in the future, and in return, the investor of the bond receives interest.

Bonds are also traded publicly on an exchange and therefore, will experience price movements. However, depending on the type of bond, these movements are usually less volatile compared to stocks but also have resulted in more modest returns.

Jemma Financial Wisdom: Because of their different risk and return characteristics, stocks and bonds are both used in an overall portfolio. However, each investor’s stock and bond allocation will likely depend on various individual factors, including investment time horizon and goals, age and risk tolerance.