December 30, 2021
You’ve probably heard of both stocks and bonds. You also might know that they’re tools that many use to build wealth.
And if you have your ear to the ground, you know that stocks and bonds aren’t created equal—stocks are usually riskier, bonds are usually safer.
But…why? What’s the difference between these wealth building vehicles?
Glad you asked! Let’s explore how stocks and bonds work.
Before we begin, bear in mind that this article is for educational purposes only. It’s not recommending one vehicle over the other or a particular strategy. It’s just illuminating the differences between two common investments.
In a nutshell, a bond is a loan, while a stock is a share.
Let’s start with bonds. Governments need money to function. Historically, they’ve kept the lights on through conquest and taxation. Conquest has fallen out of fashion in the last 100 years, and sometimes taxes just won’t cut it.
So instead of demanding more money in taxes or—yikes—printing more, governments can issue bonds.
A bond is a loan. You voluntarily loan the government money, and they pay it back with interest. You get a fixed income stream, they get to build roads and schools.
Other entities can issue bonds, like states, cities, and corporations. But when people talk about bonds, they usually mean Federal Bonds. Why? Because they’re generally perceived as safe. The U.S. government has a consistent track record of paying back bond-holders.
A stock is ownership. When you buy a stock, you’re essentially buying a tiny slice of a corporation.
Why would corporations sell ownership to the masses? Because it’s a simple way to raise money. They then can use this money to expand the business, increasing the value of their stock. Eventually, you may choose to cash out your stocks for (hopefully) a handsome profit.
Some stocks also pay a portion of their earnings to stockholders. This is called paying a dividend. Normally, it’s calculated as a percentage of your stock. For instance, a $10 stock with a 2% dividend would pay $.20 each quarter.
But there’s a major catch to buying stocks—they are far less stable than federal bonds. That’s because corporations can experience bad years and even bankruptcy.
And when that happens, stockholders lose money. So while there’s potential reward for buying stocks, there’s also more risk.
That’s why it’s absolutely critical to work with a financial professional if you want to start investing in either stocks or bonds. They have the knowledge and experience to guide you in wealth building decisions based on your goals.