Lots of people wonder if it’s better to own stocks or bonds (directly or through mutual funds). The answer is that it depends. But what it depends on is a tad complicated. A big part of achieving your investment objectives (i.e., having enough money to buy the stuff you want and need) is determined by the types of assets in your portfolio. That’s because different investments behave in different ways. They have different types of risks and deliver different types of returns.
So, before you make any investment decisions you need to know figure out what you’re trying to accomplish. It also helps to understand which type of investment return is more likely to get you to that accomplishment.
The Distinguishing Characteristics of Stocks and Bonds
If you think there’s some equivalency between stocks to bonds, think again. They are different asset classes (those are the components that make up an asset allocation, which for the most part defines a portfolio’s expected return).
One way to see how these asset classes are different is to look at your own personal finances, specifically your house.
The deed’s in your name. But you may have a mortgage. That’s debt. The difference between what your house is worth and that debt is your equity. They’re related, but on completely opposite sides of your budget’s balance sheet. Here’s the investment analogy.
You generally expect your equity to increase and your house payment to stay the same. That’s similar to what’s going on with stocks and bonds.
Stocks represent ownership in a company. They’re equity. Bonds represent money lent to a company. They’re debt.
Building Wealth With Stocks
Generally, people want their home equity to increase. Coincidentally, that’s why people buy stocks. They want them to increase in value. And capital appreciation is the primary return common stocks offer.
Now, just to toss a curve ball at you, it is possible for common stocks to also provide income. Think of it like you leasing out your house.
For a public company, it’s not so much tenants paying rent, as it is excess cash from profitable operations. Sometimes companies return this excess cash to shareholders. These payouts are called dividends.
So, common stocks may deliver two types of return: capital appreciation and dividend income. It’s the capital appreciation part that’s important. People typically invest in stocks to grow and build wealth.
What a Lender gets for the Money
Both a bond and your mortgage are debt owed to a lender. The interest you pay on your mortgage is pretty much the same thing as the interest a company pays to bond investors. People typically invest in bonds for the income.
Now, your mortgage doesn’t give the lender an equity stake in your house. It could skyrocket in value and you’re the only one who profits from that.
The same is true of bonds. Like fixed mortgage lenders, bond investors earn a set rate of interest until a bond matures. Then they get their money back.
Bonds are good for creating steady income, but they typically don't offer the opportunity for material capital appreciation. This lack of a wealth building effect is why stocks generally outperform bonds.
Match Investment Returns to Financial Objectives
So, back to the beginning. Shall it be stocks or bonds? What do you choose?
Maybe it’s time to work with qualified professionals who can help you find suitable investments to help you achieve your ultimate financial objectives.
For answers about matching investments to your return expectations, speak with one of our Investment Specialists. They’re available Monday-Friday 7:30am to 8:00pm (CT) at (800) 235-8396.