Stocks represent ownership while bonds represent debt. When you buy a stock, you are buying partial ownership in a company, which entitles you to share in both the profits and losses of that company. When you buy a bond, you are lending your money to the bond issuer with the goal of being repaid in the future, plus interest.
Stocks and bonds can play an important role in almost every financial plan. Stocks are commonly used to generate growth in a portfolio for future financial goals. They can also be used for a broad range of other financial objectives, such as generating growth and income, or sometimes simply generating income alone.
Bonds are commonly used to generate income for current financial needs, such as day-to-day living expenses in retirement. They can also be used to generate total return in a portfolio, as well as reduce volatility in a portfolio that contains both stocks and bonds.
Risk and Reward
Stocks and bonds have historically provided greater average annual returns than what you might earn in a typical savings account. In exchange for that higher level of return, you also take on a higher level of risk.
With stocks, you face the risk that stock prices may fluctuate over the short term. In addition, you face the risk that a company could go bankrupt, leaving your investment in that company’s stock worthless. With bonds, you face the risk that changes in interest rates could negatively affect the price of your bond. In addition, you face the risk that a bond issuer may default on its interest or principal payments.
These risks can be potentially reduced through careful financial planning, but they can never be eliminated. Make sure that you fully understand the risks of any investment strategy before investing your money.