What’s Best To Invest: Bonds Or Stocks? (2024)

Table of Contents

  • Bonds vs Stocks: Which Is Better When Rates Are High?
  • Stocks vs Bonds: Key Differences
  • Protection From Price Swings
  • Bottom Line
  • Frequently Asked Questions (FAQs)

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The past few years have shown that all investments, no matter the type, are subject to market fluctuation and can never guarantee endless cycles of growth.

Whether its property, cryptocurrency, the stock market or bonds, investors have faced periods of intense volatility, prompted by the Covid-19 pandemic and, more recently, by rising interest rates.

While there are many types of investments, stocks and bonds are two of the more popular options for Australian investors and both have been affected by inflationary pressures, according to Jordan Miyakawa, Head of Research at IMC Trading.

In fact, in the first half of 2022, the ASX200 declined by 17%, Miyakawa says, before returning to trade within a whisker of its highs earlier this year on premature hopes of an end to the rate hiking cycle.

“Bonds weren’t immune to inflation-driven interest rate reset either,” Miyakawa tells Forbes Advisor.

“For example, the yield on Australia’s 10-year government bond rose 3.5% between 2021 and 2022. Given that the price of most bonds are inversely related to interest rates, many posted negative returns during this period, with their coupon payments insufficient to offset the drop in their prices.”

As a result, many Australian investors are weighing up whether bonds or stocks are the best choice of investment in the current climate. As with all investments, the answer remains subjective: there are both pros and cons to investing in both asset classes.

Bonds vs Stocks: Which Is Better When Rates Are High?

“Generally speaking, bonds as an asset class are less risky than stocks,” Miyakawa says. Meanwhile, stocks provide higher returns, but with higher volatility.

“However, high inflation and its impact on interest rates have made answering this question [of which is better to invest in] more complex.”

In this environment of high interest rates, Miyakawa says it’s important to focus on “their direction”.

“That’s because if economic activity holds up when interest rates rise, stocks will continue to provide higher returns along with higher volatility.

“On the other hand, if inflation and interest rates decline alongside a more serious economic downturn or even a recession, bonds are the safer investment.”

Stocks vs Bonds: Key Differences

Let’s explore the key differences between stocks and bonds.

Stocks

Purchasing stocks is the process of purchasing a piece of the company. The more stocks you buy in a company, the more of the company you own; that’s where the term ‘shares’ comes from, as you are purchasing a share in the publicly listed company.

The general public can purchase shares via the stock market, with different exchanges available in different countries. In Australia, this is the Australian Securities Exchange (ASX). Australian companies that are publicly traded are listed on the ASX for investors to purchase or sell shares.

If the company performs well, the value of the company’s shares will increase. If you sold these shares after the value increased, you would turn a profit. Of course, the inverse is also true: if the company performs poorly, the value of shares will decrease. In this case, you would lose money.

Since the share market is constantly moving while trading is open, the value of shares is constantly fluctuating. This constant movement makes investing in shares a difficult process, as investors can see large amounts of growth or losses in a matter of minutes.

It is often advised that people do not buy into these quick changes in value, and rather hold stocks over a period of time in companies that have a history of demonstrated growth. However, past performance is not an indicator of future performance.

Bonds

On the other hand, bonds are considered a safer asset to invest in as they offer a fixed rate of return rather than a fluctuation in value. The disadvantage is that they also do not reach the highs in values that stocks experience when companies are performing well. In periods of high inflation, it may mean that your fixed rate of return is lower than the CPI.

When investing in bonds, you are lending money in return for regular payments (known as coupon interest payments). Rather than buying a part of the company like you do with shares, bonds involve you, the investor, lending the company, or the government, money.

You are then paid interest for a set period of time and, once the bond matures, you will be paid back the full amount you purchased the bond for. If a company defaults during this period, however, you’ll stop receiving payments and won’t be paid back for your initial investment.

As the Australian Government has never defaulted on the interest or repayment of the principal payments on the bonds, government bonds are considered particularly safe. Corporate bonds, however, are more similar to the risk profile of shares and ASIC warns consumers to be wary of corporate bond offers that seem too good to be true.

Protection From Price Swings

Ultimately, high-quality bonds–in particular government bonds–should deliver solid returns on safe-haven demand during times of economic turbulence, Miyakawa says, even outperforming stocks. That’s because stocks can come under pressure from the impact of earnings and they fluctuate much more dramatically even over short periods of time.

“With interest rates already at high levels, there are now a lot of high-quality bonds available in the market offering attractive interest rates,” Miyakawa explains.

“Certain government and investment-grade corporate bonds can deliver strong returns with lower risk than stocks. Holding these bonds until maturity can ensure you collect these interest and principal payments without being exposed to temporary price swings as interest rates move around, assuming the bond issuer doesn’t default, of course.”

The key point to note is holding the bonds until maturity to ride out any turbulence in the market.

Miyakawa also points out that the type of bond plays a key role in its performance, as “riskier corporate bonds perform similarly to stocks, delivering negative returns with high volatility”.

Bottom Line

Australia’s economy has held up fairly well when considering the cumulative 4% of RBA hikes in little over a year, Miyakawa says.

This resilience, and the perception that rates are near or at the peak both at home and abroad, have allowed stocks to stage an impressive recovery. Bond prices, meanwhile, have remained sluggish as rates stay elevated.

“Although the soft-landing scenario could easily continue to play out and boost the stock market further, there remains uncertainty over the economic outlook. We know that the economy is impacted by interest rates with a lag and there are spots of weakness showing, Miyakawa says.

“If there is a more serious economic downturn, stocks could have a fair way to fall.”

While there seems to be a better asymmetric payoff with bonds, it is still essential for investors to do their due-diligence to minimise default risk.

Ultimately, Miyakawa says, whether bonds or stocks are the better investment when inflation and interest rates ease, depends largely on one’s risk tolerance and their expectation for economic growth.

When investing, it’s possible to lose some, and very occasionally all, of your money. Past performance is no prediction of future performance and this article is not intended as a recommendation of any particular asset class, investment strategy or product.

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Frequently Asked Questions (FAQs)

Do bonds or stocks have better returns?

Typically, stocks tend to perform better than bonds in terms of offering higher returns. With that reward, however, comes higher risk. Stocks are more volatile than bonds, so investors may risk losing some or all of their investment–or even find themselves at a loss.

Bonds, meanwhile, are seen as a more safe-haven investment, as holding a bond until maturity will usually see a payout higher than your initial investment, thanks to regular coupon payments and the return of your initial investment, as long as the bond does not default.

Which is riskier: bonds or stocks?

Stocks are seen as more of a risky investment due to their volatility. When investing in stocks, there is no guarantee that you will turn a profit upon selling the stocks; in fact, you could lose your initial investment and then some. Stocks are tied to a company’s performance and can fluctuate in a matter of minutes when the stock market is open for trading.

This constant change can result in investors buying and selling stocks frequently, trying to make a profit. Bonds, on the other hand, are best held until they reach maturity, and are seen as a much safer investment due to less volatility.

Should I buy bonds or stocks right now?

As with all investments, there is no one size fits all. Whether or not you should invest in bonds or stocks at any given time depends entirely on your risk appetite and expectation for growth. If you want to run the gauntlet of achieving high returns, stocks are your best chance at doing so–yet they also come with the risk of losses. If you would prefer to receive regular repayments and the return of your initial investment eventually, then investing in a bond may be more suitable for your portfolio.

Regardless of the type of investment you purchase, turning a profit is never guaranteed.

What’s Best To Invest: Bonds Or Stocks? (2024)

FAQs

What’s Best To Invest: Bonds Or Stocks? ›

Key Takeaways. Stocks offer the potential for higher returns than bonds but also come with higher risks. Bonds generally offer fairly reliable returns and are better suited for risk-averse investors.

Which is better to invest, stocks or bonds? ›

Stocks offer an opportunity for higher long-term returns compared with bonds but come with greater risk. Bonds are generally more stable than stocks but have provided lower long-term returns.

Why are bonds the best investment? ›

Bonds tend to be less volatile and less risky than stocks, and when held to maturity can offer more stable and consistent returns. Interest rates on bonds often tend to be higher than savings rates at banks, on CDs, or in money market accounts.

Are bonds a good investment now? ›

Short-term bond yields are high currently, but with the Federal Reserve poised to cut interest rates investors may want to consider longer-term bonds or bond funds. High-quality bond investments remain attractive.

Why would someone buy a bond instead of a stock? ›

Bonds are more beneficial for investors who want less exposure to risk but still want to receive a return. Fixed-income investments are much less volatile than stocks, and also much less risky.

Which is safer to invest in stocks or bonds? ›

In general, stocks are riskier than bonds, simply due to the fact that they offer no guaranteed returns to the investor, unlike bonds, which offer fairly reliable returns through coupon payments.

Why are my bonds losing money? ›

What causes bond prices to fall? Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.

What is the best investment right now? ›

11 best investments right now
  • High-yield savings accounts.
  • Certificates of deposit (CDs)
  • Bonds.
  • Money market funds.
  • Mutual funds.
  • Index Funds.
  • Exchange-traded funds.
  • Stocks.
Mar 19, 2024

What is the downside to bonds? ›

What are the disadvantages of bonds? Although bonds provide diversification, holding too much of your portfolio in this type of investment might be too conservative an approach. The trade-off you get with the stability of bonds is you will likely receive lower returns overall, historically, than stocks.

What are the pros and cons of bonds? ›

Types of bonds: Advantages and disadvantages
  • Advantages: Safety and low risk, thanks to backing of U.S. government.
  • Disadvantages: Limited growth potential and prices will fall if rates rise.
Jan 29, 2024

How much is a $100 savings bond worth after 30 years? ›

How to get the most value from your savings bonds
Face ValuePurchase Amount30-Year Value (Purchased May 1990)
$50 Bond$100$207.36
$100 Bond$200$414.72
$500 Bond$400$1,036.80
$1,000 Bond$800$2,073.60

Do bonds do well in recession? ›

Bonds, particularly government bonds, are often seen as safer investments during recessions. When the economy is in a downturn, investors may shift their portfolios towards bonds as a "flight to safety" to protect their capital. This shift increases the demand for bonds, raising their price but reducing their yield.

Can you lose money on bonds if held to maturity? ›

After bonds are initially issued, their worth will fluctuate like a stock's would. If you're holding the bond to maturity, the fluctuations won't matter—your interest payments and face value won't change.

Are bonds safe if the market crashes? ›

Do Bonds Lose Money in a Recession? Bonds can perform well in a recession as investors tend to flock to bonds rather than stocks in times of economic downturns. This is because stocks are riskier as they are more volatile when markets are not doing well.

When to move from stocks to bonds? ›

During a bear market environment, bonds are typically viewed as safe investments. That's because when stock prices fall, bond prices tend to rise. When a bear market goes hand in hand with a recession, it's typical to see bond prices increasing and yields falling just before the recession reaches its deepest point.

What is the average return on bonds? ›

The bond market is a wide field, with many different categories of assets. In general, you can expect a return of between 4% and 5% if you invest in this market, but it will range based on what you purchase and how long you hold those assets.

What are the cons of a bond fund? ›

The disadvantages of bond funds include higher management fees, the uncertainty created with tax bills, and exposure to interest rate changes.

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