Stocks don’t always beat bonds and bonds aren’t always low risk: What matters are regimes (2024)

FAQs

Which one is riskier bonds or stocks? ›

Given the numerous reasons a company's business can decline, stocks are typically riskier than bonds. However, with that higher risk can come higher returns. The market's average annual return is about 10%, not accounting for inflation.

Bonds in general are considered less risky than stocks for several reasons: Bonds carry the promise of their issuer to return the face value of the security to the holder at maturity; stocks have no such promise from their issuer.

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.

Valuation of a stock is more difficult compared to bond valuation because stocks lack a maturity value. The prediction of the future amount of money that is related to stock is hard since it bases upon the profitability of a company and the amount of money that can be distributed to the stockholders.

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.

Money market accounts, certificates of deposit, cash management accounts and high-yield savings accounts all carry FDIC insurance. Treasury bills, notes and bonds are backed by the U.S. government, making them another low-risk investment option.

Stocks are much more variable (or volatile) because they depend on the performance of the company. Thus, they are much riskier than bonds. When you buy a stock, it is hard to estimate what return you will receive over time (if any). Nonetheless, the greater the risk, the greater the return.

Short-Term Bond Funds

Short-term bond funds most often invest in bonds that mature in one to three years. The limited amount of time until maturity means that interest rate risk is low compared to intermediate- and long-term bond funds.

Treasuries are generally considered"risk-free" since the federal government guarantees them and has never (yet) defaulted. These government bonds are often best for investors seeking a safe haven for their money, particularly during volatile market periods. They offer high liquidity due to an active secondary market.

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.

What are the cons of bonds? ›

Should I only buy bonds when interest rates are high? There are advantages to purchasing bonds after interest rates have risen. Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels.

While bonds have less risk than stocks, investors should also consider the opportunity cost. The money you put into a bond cannot go into a stock that can produce higher returns. Taking a guaranteed 3% return prevents you from using the same capital to buy a stock that goes up by 10%.

In the short run, as the Fed starts fighting, it can be painful for stocks. But over the long run, as you see companies pass along price increases—they're what we call real assets—they tend to grow earnings and dividends along with inflation.

Historically, bonds have generated stronger risk-adjusted returns compared to stocks in the three years following Federal Reserve tightening cycles. After the past seven tightening cycles, bonds delivered 89% of the return of stocks with only 26% of the volatility with more consistency in their range of outcomes.

Preferred stock is a hybrid security that integrates features of both common stocks and bonds. Preferred stock is less risky than common stock, but more risky than bonds.

Stocks have historically delivered higher returns than bonds because there is a greater risk that, if the company fails, all of the stockholders' investment will be lost (unlike bondholders who might recoup fully or partially the principal of their lending).

The Basics: Cash, Money Market Funds, and Bond Funds

Bond funds invest in various fixed-income securities and offer a higher potential return than money market funds but also come with greater risk.