Bonds or Stocks? - Pros and Cons

There's no question stocks get a lot more press. The average investor may never have bought a bond, even after dabbling in Exchange Traded Funds, Futures or even more esoteric investments. Nevertheless bond prices are easier to predict, risk is often low yet with returns that are healthy.

Picking a stock and seeing its price rise by 10 percent overnight is a thrill. Seeing it double in six months makes the investor feel either very lucky or very smart. But with that comes considerable risk. Stock prices tend to be much more volatile - experiencing larger and more rapid swings.

Bonds come in much greater variety - from the unexciting but reliable U.S. or corporate AAA 10-year that pays a small yield to the heart-pounding junk bonds that can offer 15% or more. As with any investment, so it is with bonds: calculated risk vs intended reward is a standard trade-off. But risks tend to be both lower and more readily calculable in the bond market.

The capital needed for initial investment can be higher. A hundred shares of $10 stock generally buys only one bond. Still, there are mutual funds that invest primarily in bonds and other 'pay as you go' plans available. Your broker can provide information on specific programs.

Bonds are sometimes slightly harder to trade, requiring a phone call (with a correspondingly higher commission) rather than just a few mouse clicks on an Internet trading screen. Also, unlike stocks generally, not all bonds are traded by all brokers. Again, your broker - whether full-service or only Internet/Discount - will list the options. And there's no law that says you can't have more than one account.

Bonds are less volatile in the short-term, but they tend to be more sensitive to certain economic factors - particularly anything influencing interest rates. Stock dividends can be viewed as a kind of interest paid on share ownership, but they tend to be less popular these days and are subject to the whims of management. Bonds always carry a coupon rate.

Those coupon (interest) rates are fixed at time of issuance and are, naturally, going to be compared with other interest bearing investments by anyone interested in purchasing your bonds before maturity. (Maturity is the date on which the principal of a bond must be repaid in full.) And, bond prices are affected, not only by comparing their coupon rate against other investments, but by how close they are to maturity.

Governments influence bond prices much more directly than those of equities (stocks). Government creates effects through setting Prime Rate lending rates, through massive borrowing - either by issuing bonds themselves, or other means - and by enacting legislation that affects banks, insurance companies and other large institutions more directly than other businesses.

All this being so, it remains true that one fundamental rule of prudent investing is diversification. Either through direct purchase or via mutual funds, bonds offer relatively reliable and healthy returns on invested capital. They should be part of any portfolio.