What's The Difference Between Shares and Bonds?

Posted by Simon Moore on July 24
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When you're getting started with investing, you might hear that shares and bonds can be sensible choices for your portfolio, but what are they?

Let's start with what shares and bonds have in common. Both of them are investments that are designed, over time, to pay you back more than you invest. So, assuming things go well for the overall economy, investing in shares and bonds can be a way to make your money grow. However, this happens in slightly different ways. 

How Bonds Work

Bonds are generally more predictable. With a bond you typically get paid a fixed amount each year, called interest. So with a bond the amount you receive is often a little more predictable than with shares.

Also, paying interest on bonds is very important to the company, or government, that issues them. If interest is not paid, then the company may go bankrupt, so they take paying interest on bonds very seriously. This is a good thing for bond investors. It doesn't mean you always receive interest on a bond, but if you don't, then the company or government that issued the bond is in very serious trouble. For high quality companies, failing to pay interest on bonds is an unusual event.

How Shares Work

Shares are a little bit different. You basically receive a stake in the profits a company makes. These profits can be less predictable. Shares may pay you dividends, but these aren't like interest on a bond. A company can cut the dividend if they get into trouble, and it's far less serious than missing an interest payment on a bond. So what you get when you buy a share is a lot less certain.

However, uncertainty isn't always bad, if things go well for a company, then shares can work out to be a great investment. If sales for a company rise just a small amount, then shareholders can really benefit as profits rise, whereas bond holders still receive the same amount of interest. So bond investors have more protection if things go badly, but shareholders can do much better when things go well. Historically, shares have been a better investment for the long-term, than bonds, but with bigger ups and downs along the way.

Combining Shares And Bonds

So, shares are a little riskier but can offer a better return when things go well. Bonds are a bit more predictable and can hold up better when things go badly.

As you may have noticed, combining the shares and bonds is often considered a good idea. In this way, shares can help your return in good markets, but bonds can offer a more stable return in bad markets. That's why most professionally managed portfolios combine stocks and bonds for investors.

If you'd like to learn more about these topics, we also have a set of short videos explaining different investing concepts.

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Written by Simon Moore

He was previously CIO of FutureAdvisor, a US digital advisor. His most recent book Digital Wealth, explains automated investing. He studied economics at Oxford, and completed his MBA at the Kellogg School of Management.

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