What are the differences between stocks and bonds?

What are stocks?

Stocks represent shares of ownership in a company. When you purchase a stock, you acquire an equity stake in the business, which usually entitles you to a proportional portion of its earnings and voting rights for its corporate decisions. The simplest way to think of stock ownership is that in general you become, while you hold the stock, a part owner in the business.

Stockholders benefit from company growth through share price appreciation and often dividend distributions. If a company performs well, its stock price increases, benefiting shareholders. Of course, if the business struggles, its stock tends to fall, leading to potential losses.

Investors and traders also sometimes use leverage enhance returns, though this comes with higher risks.

What are bonds?

Bonds — in their simplest form — are debt instruments. When investors buy bonds, they effectively lend money to a government or business in exchange for consistent interest payments (the coupon) and the eventual return of the principal amount at maturity.

Because bonds provide fixed-income streams, they are generally considered safer investments than stocks, though as with any debt this does depend on the credit rating of the government or business you’re lending to.

Bondholders are almost always prioritised over shareholders in case of bankruptcy, making bonds more secure. However, bond prices fluctuate inversely with interest rates, meaning that when interest rates rise, bond prices typically fall, and vice versa.

How to invest in stocks or bonds with us

1. Learn more about stocks and bonds
2. Download the IG Invest app or open a share dealing account online
3. Search for your desired stock or bond on our app or web platform
4. Choose how many shares you’d like to buy
5. Place your deal and monitor your investment

Investors look to grow their capital through share price returns and dividends - if paid.

But the value of investments can fall as well as rise, past performance is no indicator of future returns, and you could get back less than your original investment.

Types of stocks

There are as many different stocks as there are publicly listed companies in the world, covering the full gamut of jurisdictions and market segments. However, a key starting point is the distinction between common stock and preferred stock: the former confers voting rights and profit shares, while the latter provides fixed dividends, making it resemble a bond in stability.

Beyond this, stocks can be classified into many different categories, including technology, resource, health and real estate. Broadly speaking, many investors split stocks by market capitalisation — where you have large caps (including blue chips), mid-caps and small caps. Blue chips are leaders in their industries, known for their financial stability, strong brand recognition and consistent performance.

Among these categories, you have growth stocks, which are expected to grow at an above-average rate compared to the market. They typically reinvest earnings rather than paying dividends. You also have dividend stocks, which are dominated by larger, financially stable companies which provide shareholders with regular income through dividend payments, generally at the expense of growth.

Another popular category is value stocks, which are shares of companies that are perceived to be trading below their intrinsic value, often based on fundamentals like earnings or sales.

The bottom line is that there are hundreds of ways to categorise stocks — and every investor needs to research companies to find out which type of stock they prefer. However, a key theme among all investors is diversification — which means splitting your investment across different asset classes, industries, and geographies to reduce risk, by minimising the impact of any single investment's poor performance.

Pros and cons of stocks

As with all investments, there are many advantages and drawbacks to stocks.

Pros of stocks

• Long-term returns — in general, stocks offer a high long-term return potential compared to other asset classes
• Appreciation — stockholders enjoy an ownership stake in companies with potential appreciation
• Dividends — some stocks provide dividend distributions, offering passive income
• Accessibility — thousands of stocks are easily accessible with us on our platform or our app

Cons of stocks

• Volatility — short-term volatility can lead to significant share price fluctuations, which can be unsuitable for investors with a low risk tolerance
• Loss risk — there is also a risk of permanent loss if a company performs poorly or fails
• Sentiment — stockholders often suffer emotional challenges when holding investments during market downturns
• Time requirement — company research and active management is often needed to increase the chances of share price gains

Types of bonds

Bonds are perhaps a little more constricted than stocks; but like stocks, each comes with their own risks and rewards. Government bonds like treasury bonds in the US — or Gilts in the UK, named for the golden edge of the paper they were originally printed on — are considered the safest kinds of bonds with low default risk.

Most countries issue their own international bonds which offer diversification but may carry currency and geopolitical risks. Emerging market bonds offer higher risk-reward profiles — a higher return but increased chances of default. As a general rule, the risk rises if the credit rating of the issuing country is weak, but so does the interest on offer.

Corporate bonds are also popular. These are issued by companies to raise capital and can range from low-risk investment-grade bonds to higher-yield, high-risk junk bonds. A subset of corporate bonds is convertible bonds, which can be converted into a predetermined number of the issuing company's shares, usually at the bondholder's discretion. They provide lower yields than regular corporate bonds but offer an upside if the stock price rises.

It’s worth noting that corporate bond yield spreads are a strong indicator of recession — widening spreads usually indicate rising corporate risk, while narrowing spreads reflect investor confidence and wider market strength.

Inflation-protected bonds are perhaps the most popular bond subtype as they adjust their principal value based on inflation rates. These bonds help investors preserve purchasing power, making them a hedge against rising prices but offering lower yields than standard bonds.

One final bond type worth mentioning is green bonds, which is a relatively new category designed to finance environmentally friendly projects. They can be issued by both governments and businesses and attract ESG-focused investors.

Just like stocks, investors need to conduct thorough research into the bond market as there are thousands available with unique characteristics.

Pros and Cons of bonds

Just like stocks, bonds come with their own benefits and setbacks.

Pros of bonds

• Lower volatility — when compared to stocks, bonds are less volatile which generally means more portfolio stability
• Predictability — the coupon (interest) is set when you buy the bond, so you have consistent interest payments
• Safety — bonds typically offer safety during economic downturns and recessions, which can be attractive as stocks tend to fall in these times
• Tax advantages — some bonds, such as gilts, can provide tax advantages

Cons of bonds

• Returns — generally bonds offer lower long-term returns compared to stocks
• Inflation — bonds are susceptible to interest rate risks, because rising rates reduce bond prices, and also erodes the real purchasing power of their fixed-income payments
• Credit risk — not every bond is safe, and sometimes some corporate and high-yield bonds fail to pay out

Stocks vs bonds

The general idea with all investing is to build wealth over time. The reality is that for most retail investors, starting a viable business or investing in real estate has too high a cost for entry — but nowadays, stocks and bonds can be accessed via our platform in seconds — and allow you to invest in the largest companies and government debts in the world at the touch of a button.

Historically, a 60% to 40% portfolio split between stocks and bonds has been effective in generating returns — and would have returned circa 7% per year over the past decade if you invested in a global index tracker and high credit government bonds. However, your personal risk tolerance among other factors could make a different stock to bond proportion right for you.

For example, younger investors with a long-term horizon may favour stocks for their growth, while older investors approaching retirement may lean more toward bonds.

The key concept to grasp is that stocks and bond sport an inverse correlation — stocks tend to perform well during periods of economic growth, while bonds provide stability due to their consistent income during downturns. Nevertheless, during inflationary cycles or aggressive interest rate hikes, both asset classes can decline simultaneously, as was the case in 2022.

There are many metrics for measuring risk-adjusted returns from stocks and bonds, including the Sharpe ratio, which evaluates return per unit of risk, the Sortino ratio, which adjusts for downside risk and negative volatility, and the Treynor ratio, which assesses the asset’s return relative to overall market risk.

Different investors prefer to use different metrics when assessing stocks against bonds, but all need to bear in mind their time horizon, risk tolerance, and market conditions.

Other comparative methods include risk parity, which allocates investments based on risk exposure rather than capital weight — alongside complex techniques such as derivatives hedging, or dynamic rebalancing which continually adjusts stock to bond ratios within a portfolio periodically, to maintain an optimal risk-return profile.

Stocks and bonds summed up

• Stocks represent shares of ownership in a company. When you purchase a stock, you acquire an equity stake in the business
• Bonds are where you lend money to a government or business in exchange for consistent interest payments and the eventual return of the principal amount at maturity.
• Historically, a 60% to 40% portfolio split between stocks and bonds has been effective in generating returns
• Investors should consider their time horizon, risk tolerance, and market conditions when investing in stocks and bonds