Bond Portfolio Vs. Stock Portfolio

Understanding differences in stock and bond dynamics helps take maximum advantage of Wall Street opportunities

Stock and bond returns are based on different risk/return dynamics. Generally speaking, stocks are more volatile than bond portfolios, providing higher capital gains on invested capital at higher risk. Direction of price change between two asset types is measured by correlation.

Bond Inflation Risk

Inflation can erode bond returns. For example, a return of nominal 4 percent in a given year is minus-1 percent in real dollars if inflation was 5 percent that year.

Stock Principal Loss Risk

Stocks represent a claim of future profits instead of debt obligated to be paid back. With stocks, there is no legally binding promise of any profit to the stockholder.

Bond Yield

Bond returns have less variability than stock returns. Most bonds do not suffer the magnitude of capital loss characteristic of stocks, but neither do they yield as much of a positive yield during good times.

Stock Capital Gain

During good times, a diversified stock portfolio typically higher returns than bonds, beating inflation. However, a downswing can be severe. In the 2008-2009 recession, the Standard and Poor's 500 dropped 16.79 percent during October 2008 alone.

Correlation

Positive correlation between securities indicates that when one rises, so does the other. Negative correlation means that when one security type rises, the other falls. Low or negative-correlated stock/bond combinations can give substantial long-term yield without excessive risk.

References

• Securities Industry and Financial Markets Association (SIFMA). "Risks of Investing in Bonds"
• InvestorGuide University. "Measuring a Stock's Risk"
• University of Winconsin-Whitewater. "Money and Banking: Introduction to Interest Rates"

Resources

• Cornerstone Investment Services. "The 100 Year Dow Jones Chart"
• Legg Mason Capital Management. (LMCM) "Market Commentary, October 2008"
• Terms Definition, Investopedia. "Correlation"