Most portfolios are built mainly from two things: stocks and bonds. They earn money in different ways, carry different risks and play different roles. Understanding the difference makes almost every other investing decision easier.
How stocks make money
A stock is a small share of ownership in a company. You can earn a return in two ways:
- Price growth: if the company grows its profits over time, investors are usually willing to pay more for its shares.
- Dividends: some companies pay out part of their profits to shareholders in cash.
Neither is guaranteed. Profits can shrink, dividends can be cut, and share prices can swing sharply on news, sentiment or the economy. In return for that uncertainty, stocks have historically offered higher long-term returns than bonds or cash.
How bonds make money
A bond is a loan. When you buy one, you lend money to a government or company, which promises to pay you interest at set intervals and return the original amount, the principal, when the bond matures.
- Interest (the coupon): a $1,000 bond paying 4% a year provides $40 of interest annually.
- Price changes: bonds can be bought and sold before they mature, and their prices move as interest rates change.
The main risks are that the borrower fails to pay (credit risk) and that rising interest rates push down the price of existing bonds (interest-rate risk). High-quality government bonds carry very little credit risk; lower-rated corporate bonds pay more interest because they carry more.
Side by side
| Stocks | Bonds | |
|---|---|---|
| What you own | Part of a company | A loan to a borrower |
| How you earn | Price growth and dividends | Interest, plus or minus price changes |
| Typical ups and downs | Larger | Smaller |
| Long-term return potential | Higher | Lower |
| Main role in a portfolio | Growth | Stability and income |
Why most portfolios hold both
Stocks drive long-term growth; bonds tend to soften the ride. High-quality bonds have often held their value, or even risen, when stocks fell sharply, though not always. How much of each to hold is the question of asset allocation.
Key takeaway
Stocks pay you for taking on business risk; bonds pay you for lending money. Holding both lets you balance growth against stability in a way that suits your goals.
This guide is for education only and isn’t personal financial advice. Investing involves risk, including the possible loss of money you invest. Example figures are illustrations, not predictions.