I’m a finance nut but I get a pile of questions about stocks vs bonds and what or when people should buy them. So, I’m putting an end to it today in this lightning fast (yet very educational) post.
As a guy who’s obsessed with both time and money, I have some pretty strong opinions about what’s smart and what’s efficient. With this quick read you can feel stable and prepared in any economy.
So, what exactly are stocks and bonds, and why should you care?
Stocks vs Bonds: What are stocks? A fraction of a company
Stock: A stock is an investment that equates to actual ownership of a company.
Sounds cool right? You get to own a company. Anything you want. Tesla is cool? Buy it! Nothing to it!
Really it’s only a tiny fraction of the company that you’re buying because let’s be honest, $11 isn’t a lot compared to the corporate giant that is GE, but for $11 you can buy a teeny tiny piece. That piece is called a stock.
You own that fraction of the company and now you are owed the corporate profits! Hurrah! Or if the company gets bigger and you own 0.1% of it. Your chunk grows too. This is how stocks make you money.
Historically that growth is on the order of 10% and it’s quite frankly the main way everyone in the world invests successfully.
Why do stocks exist?
Let’s pretend a company successfully grows out of its start-up era and becomes bigger. Probably the founders want to expand more but they don’t have enough money to do so solely through their revenue from operations.
So, to bring in some money for expansion they sell off parts of the company as stocks (it’s called an IPO).
Or more selfishly, the owner might just want to cash out on their success by selling off a chunk of the company. Zuckerberg made over $1B the day of the Facebook IPO and I can’t blame him for wanting to put a bit of that money in his pocket.
Most people aren’t going to show up with over $1B in cash so in that case Facebook chopped it up, so 1 share was $38, thus letting normal people buy it.
Stocks vs Bonds: What are bonds? Debt:
Bond: A Fixed Income Instrument representing a loan.
What does the above mean? Not a lot.
Bonds are weird. They have weird terms and weird rules but they are SUPER important. I would argue more important than the entire stock market (I wrote a big article on them because of that).
Bonds are another way to raise money for a company. In this case, the company (or government) just offers to hand out some debt and pay you back plus interest at a set interest rate. It’s essentially an IOU.
- Companies handing out debt like this because they get to keep more of their future growth-based profits that they would lose if they issued stocks.
- Investors like it because bonds are predictable. Interest rate = 4% per year for 4 years. It’s in the contract.
Bonds and stocks: What it means for investors?
- Stocks are more about investing in a company’s future. You own some stock and you hope they are profitable and grow since that will earn you money.
- Bonds are just about getting something. You buy some bonds and you get paid regardless of how everyone is doing.
- The only situation where you don’t get your full payout with bonds is if the company goes bankrupt…but the shareholders get nothing either! So you still win, I guess.
This turns stocks into more of a rollercoaster with bigger upsides and downsides but on average the upside is way higher. You just need to be able to absorb the down years when they come.
At the same time, that’s why bond markets are huge. Pension funds, insurance companies, and entire countries need TONS of money on hand for the bad years.
Indexes: A beautiful twist
It’s no secret that I love index funds. Indexes are an amazing twist on stocks and bonds. When you buy a stock index you buy into a pool that owns lots of stocks.
For example, buying 1 share of VTI (an overall US stock index I like you can buy on the stock exchange) is $205 today. 1% of that $205 is allocated to VISA and the other 99% is in other companies.
Your $2.05 investment in Visa gets you a whopping 0.0000000005% of the $442.54B company! Yeah it’s tiny but it’s the same idea as the shares being little chunks of a company, but with an index you chop it up even more (read this to get why it’s so damn amazing).
Bond index funds are the same. Buy into 1 bond index (aka. BND on the stock exchange) and own lots of different bonds.
Stocks vs. Bonds. So what should you choose?
Tying it back together. What should people buy and when?
It’s good to have both stocks and bonds.
Why? Because financial roller coasters can be dangerous. Also because you can do some smart things with the extra stability.
How much? The easy recommendation is 70% stocks and 30% bonds. I recommend that most of the time.
Except:
- If you have piles of real estate you need emergency money for repairs and vacancies, so I recommend extra bonds (read here).
- If the stock market plummeted, then I go 100% stocks until I stop hearing about record lows.
Simple rules for an efficient life.
Stocks vs bonds: How you can buy them?
The best way is by buying index funds on the stock exchange (called ETFs). Either VTI for stocks or BND for bonds. You buy them on a stock trading platform like M1Financial (or Questrade in Canada).
There are other ways to buy bonds, like straight from the government. Read the full bond guide to get the details.
Stocks vs bonds: Short vs long term?
Over the long term stocks should give you more money back. Sure, you’ll have some low years, but these should even out over the long term.
Bonds are less risky but you lose something to ditch the rollercoaster that are stocks. That’s painful in the long term but great in the short term if you need to pay a bill or lose your job.
Read more:
Full guide to making extra money this year!
TL;DR – Stocks vs bonds
- There is a lot of jargon in investing but stocks and bonds are just owning stuff and IOUs.
- Stocks are more of a long term play that’s a roller coaster along the way.
- Keeping 30% of your money in bonds is generally smart.
- You’ll need more if you have lots of real estate, and less if the stock market has been crushed.
FAQ: Stocks vs. Bonds:
Are bonds better than stocks?
You could say consistency is better, but in a long enough term stocks should consistently outperform bonds. Bonds are better than stocks at providing consistency when you need it, such as when markets are at record highs, and when you have monthly commitments like mortgages.
Are bonds safer than stocks?
Bonds are safer than stocks in that they are less volatile, but you’ll run the risk of running out of money if you live off bonds along since the yield is so low. So the lack of volatility makes bonds safer only in the short term.
How are bonds and stocks similar?
Both are:
-Exchanged on stock exchanges
-Issued by companies to raise money
-Result in owning something. Bonds own a company’s debt, and stocks own the company itself.
-Expected to grow in value over time.
-Part of a balanced portfolio.
