Stocks vs. Bonds: What You Wanted to Know (but Were Too Afraid to Ask)
Upon my recent transition from a full-time, salaried position to the #freelancelife, I quickly discovered I needed an education in investing.
Having left a company with a generous 401(k)-matching program (*cough* The Penny Hoarder *cough*), my small nest egg and I were suddenly on our own.
My retirement is important to me, so I wasn’t going to let the money languish. I did enough research to figure out I should roll the funds over into a Roth IRA, but when I opened the online interface of my brand-new brokerage account, I was overwhelmed.
How should I “allocate my assets,” as the friendly adviser had put it over the phone? What were my options in the first place?
What’s the Difference Between Stocks and Bonds?
When it comes to investing your retirement savings, you have two main options: stocks and bonds.
Stocks are small portions, or “shares,” of a company. They’re also known as “equity.” (Because investing wasn’t confusing enough already.)
For instance, let’s say you buy a share of Lululemon. Congratulations! You now actually own a piece of the business.
The company then uses your investment to help its growth efforts. As a result, your stock increases in value if the company does well, which means you can sell it for more than your original purchase price down the line.
Of course, the opposite also holds true. If the company goes under, your money goes with it.
Bonds, on the other hand, are actually a form of long-term debt issued by either a company or a government.
As Lifehacker’s Kristin Wong puts it, “When you buy a bond, you're basically buying a debt and loaning a company (or government) money.” The growth comes in because the seller agrees to pay you interest on the loan at a fixed rate (also called a “coupon”) and schedule. The borrower must repay the entirety of the loan by a given “maturity date.”
Since you know the interest rate and term ahead of time, bonds are a much more stable, predictable investment -- and for this reason investors also call them fixed-income securities.
They do, however, tend to yield less return for investors.
Which Should I Invest In: Stocks or Bonds?
A quick caveat before we go any further: I am not a professional investor nor any kind of finance expert.
All the advice you’ll see here is from folks who, presumably, have a better idea of what they’re doing than I do.
That said, there’s no way to tell you the magic ratio that will make your investment portfolio blow up -- or fizzle, for that matter. (And even if there was, it would be super illegal to do so.)
All investment comes with some risk. You’re putting your money into an intangible entity, like ownership or debt.
But obviously, some investments are riskier than others. (R.I.P. Pets.com.)
As we established above, stocks carry more risk than bonds -- but also have a greater potential to earn you profit.
Thus, most finance professionals advise younger investors to allocate more of their funds to stocks, since they have a longer stretch of years separating them from retirement. All that time gives you a margin of error, allowing you to ride out short-term fluctuations in the market.
But if you’re a little longer in the tooth, you might want to shift your portfolio to include proportionately more bonds. They’re a surer thing and have the added benefit of an exact time frame for payoff -- useful if, for example, you know you want to retire in the next 10 years.
Of course, even bonds are not guaranteed. Occasionally, an issuer will not be able to pay off the loan.
The Motley Fool offers this guideline to help you figure out the right ratio for your retirement portfolio based on your age:
As a general rule of thumb, subtract your age from the number 110 in order to determine your target stock allocation. For example, if you're 35, this rule says that approximately 75% of your assets should be in stocks.
It’s no silver bullet, but it’s a start, and you can adjust your personal ratio from there as you see fit. For instance, if you’re willing to gamble a bit in pursuit of aggressive growth, you might change the number to 120. If you’re more conservative, you might knock it down to 100.
No matter what ratio you choose, it’s definitely a bright idea to buy a little bit of both. “Diversify!” is perhaps the most common investment advice -- and for good reason.
It’s just like that old saying about eggs and baskets. And when it comes to your retirement, you don’t want to end up with yolk on your face.
How to Get Started on Your Retirement Portfolio
Of course, there’s a whole lot more to investing than we can outline here.
And luckily, there are lots of great, free resources out there to help you. (The Penny Hoarder is one of them!)
If you’re looking for the right IRA, check out NerdWallet’s top picks for 2017. Many brokerage accounts and management companies offer free advice and guidance, even if you’re not an account holder. All you have to do is pick up the phone.
And if you work for a company that offers a 401(k), don’t be shy about asking the company accountant for details... and for goodness sake, if there’s a match, take the money.
No matter what you do, just make sure you do something. That retirement isn’t going to pay for itself.
Your Turn: What’s your preferred ratio of stocks to bonds?
Jamie Cattanach (@jamiecattanach) is a freelance writer who *just* became enough of an adult to start investing. Her work has been featured at Ms. Magazine, BUST, Roads & Kingdoms, The Write Life, Nashville Review, Word Riot and elsewhere.