Is it Better to Invest in Stocks or Bonds?

Asset allocation is dividing a portfolio between stock, bonds and other investment types.

For investors, stocks and bonds are the two main choices for putting investment money to work. The majority of investors will want to invest in both stocks and bonds. The proportion of investment between the two depends on the investor's investment goals and willingness to possibly lose money.

Bond Investing

Bond investing is primarily about investing for yield. Bonds are debt securities issued by corporations and government entities. Most bonds pay a fixed rate of interest, and the principal is paid back when the bond matures. The yield an investor earns is based on the credit rating of the issuer, the term of the bond and the market rates for similar bonds when the security was purchased. Bond market prices do fluctuate and a bond investor can lose money if she decides to sell a bond before it matures or the issuer defaults on the bond interest or principal payments.

Stock Investing

Stock shares are fractional ownership of a corporation. Stock investors participate in the growth of revenues and earnings of the individual companies represented by their stock. Stock investors make money from owning stocks that increase in value. The value of a stock can increase to many times the original value for a good company held as a long-term investment. At times, stock share prices can decline significantly. During the stock bear market of 2008 to 2009 the value of many stocks declined by 50 percent or more. By 2011, the stock market had nearly regained its 2008 values. Stock investors also may earn dividends if the stocks they own decide to pay out a portion of profits as distributions to investors. For large, well-known stocks, dividends often make up a significant portion of the total return.

Asset Allocation

Simple asset allocation is how an investor divides her portfolio between stocks and bonds. The Securities and Exchange Commission states that an investor's asset allocation should be based on her time frame and risk tolerance. An investor with a longer time frame should allocate a higher portion of a portfolio to stocks. As the time the money will be needed gets closer, the asset allocation can shift to a higher percentage of bonds. Investors with a low risk tolerance will want to keep more assets in bonds and use a small percentage of the investment portfolio for stocks.

Choosing Stocks or Bonds

In each category of stocks or bonds, there is a wide range of types and quality of securities. The conservative stock investor can stick to large-cap, blue-chip, dividend-paying stocks, while an aggressive investor may want to buy small-cap companies in fast-growing sectors of the economy. Bond investors can choose from the safety of U.S. government or AAA-rated municipal bonds for safety or buy high-yield, non-investment grade bonds for extra yield and possible capital appreciation. Investments in all types of stocks or bonds can be accomplished using mutual funds or exchange-traded funds.

Resources

• Russell Investments: Stocks and Bonds
• SEC: Beginners' Guide to Asset Allocation, Diversification, and Rebalancing
• Franklin Templeton: Understanding Asset Allocation