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

“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.”

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.

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”.

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.