Stocks vs Bonds: Which One to Invest?
We’re about to look at one of the most important questions in investing and the answer isn’t what most investors think. In this video, I’ll show you the differences between stocks and bonds, how to invest and why in each. Then I’ll reveal how much to invest in stocks vs bonds at every age.
Nation, this could be one of the most important videos you watch about investing. In fact, one study found that 93% of the changes in your returns are due to what I’m going to show you today.
Unfortunately, most investors won’t watch the video. The idea of asset allocation and bond investing isn’t as sexy as picking the hottest stocks…so investors just tune out.
Stocks vs Bonds: Which is Which?
Sad but I’m here to help you, our little community in the Bow Tie Nation that wants to be a better investor. In this video, I’ll show you the difference between stocks and bonds, the pros and cons of each. I’ll then show you how to invest in both and reveal exactly how much to buy in stocks vs bonds at every age including in retirement.
We’ll start off with the basics of stocks vs bonds and for that, you need to know what each are.
Stocks are an actual partial legal ownership of a company. With that share of stock, you have a right to all the future earnings distributed while you own it. Of course the potential for those high returns also comes with the risk that there won’t be any future earnings.
Bonds on the other hand are a loan to the company, usually with fixed interest paid twice a year. If a company needs funding but it doesn’t want to sell more shares, it can borrow or sell these bonds and will only have to pay the interest each year. In a set number of years, all the way up to 30 years or even 99 year bonds in some cases, the debt is due and the company pays back the loan.
So as an investor, you get those interest payments twice a year and then your portion of the loan paid back at maturity. Obviously this is much lower risk because it’s a contractual loan but also tends to be lower return than stocks.
Stocks and bonds have pros and cons on each and very different reasons why you would invest.
Advantages of Stocks
The advantage of stocks is that potential for a higher return. Shares of Tesla are up 565% over the last year! On the downside though, stocks can be extremely volatile. Those shares of Tesla have fallen forty- and fifty-percent over a matter of months several times in the last few years.
If you’ve been able to hold on to shares through that…no problem, your investment has rebounded, but some investors have lost a tremendous amount of money whether through panicking and selling when the stock dropped or just needing the money and having to sell at the wrong time.
Advantages of Bonds
Bonds on the other hand give you the cash flow and safety you don’t get with stocks. Defaults, or bonds that don’t get repaid, are extremely low for high quality companies, less than two bonds out of 100 go unpaid.
And while everyone argues about the value of Tesla shares, how much they should be worth, bond values don’t change much because they’re based on set payments. You know exactly how much you’ll get in interest and at the end of that bond.
Pros of bond investing also include protecting a part of your portfolio from a stock crash so you can take advantage of lower stock prices when they come along. If you think stocks are expensive, you can hold some money in bonds and protect it until stocks are a better value and you’ll earn a higher interest rate than what you’d get from savings.
Next I’ll show you how to invest in each and exactly how much in stocks and bonds you should have for each age, but first I want to personally invite you to join The Daily Bow-Tie, my free daily market newsletter with all the stock market news, strategies and trends you need to follow. It’s absolutely free, just something I like to offer for everyone in the community, so look for the sign-up link in the description below the video.
How to Invest in Stocks and Bonds Without Having to Worry
Now let’s look at how to invest in stocks and bonds and a couple of strategies in each.
Buying stocks is surprisingly simple. You open an account with an online broker and can deposit directly from your bank account. You can invest in individual stocks like shares of Tesla or Apple or you can buy exchange traded funds which are groups of stocks sold as a single investment.
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Best Strategy for Investing in Stocks
The best strategy for investing in stocks, and this is something all you in the Bow Tie Nation here me recommend constantly is called the core-satellite approach.
This is where you invest most of your money in these broad ETFs, these funds that hold lots of stocks in a theme like dividend payers or tech stocks. Invest maybe fifty- or sixty-percent of your money in a few funds that give you broad exposure to thousands of stocks with the click of a button. Then with the rest of your money, you buy maybe 10 to 15 individual stocks.
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What this does is, that money in funds is a super simple investment. Since the funds are spread out across hundreds of stocks or more, you’ll never worry about one company or whether you paid a good price. You’ll get a consistent return on all the stocks in the fund.
But then with the handful of individual stocks, you get that chance for a higher return, the chance to pick the next Tesla or Apple and let it take your portfolio higher. Since it’s only ten or 15 stocks, you don’t have to spend hours analyzing and picking the right stocks…you just invest in a small group of the best stocks you can find.
How to Buy Individual Bonds
Investing in bonds is even simpler. You can buy individual bonds through an online broker but for the vast majority of investors, it’s best to just buy your bonds through an exchange traded fund that holds hundreds or thousands of these investments.
That’s because the fees to buy individual bonds can be much higher than stocks. Commissions can range from 1% to 5% on the market price of a bond and you’ll need dozens of bonds to give yourself the kind of diversification you’ll get with just one ETF. By comparison, most bond funds charge less than a quarter of a percent a year to hold the fund, so just $2.50 for every thousand dollars invested.
For example this Vanguard Long Term Bond ETF, ticker BLV, holds over 2,600 bonds in high quality companies, pays a 3.07% dividend yield and charges just 0.05% which means you pay just $0.50 in fees to the manager to hold this fund.
Another example here is the Vanguard Short-term Bond ETF, ticker BSV, which also holds thousands of individual bonds, pays a 1.7% dividend and charges the same low fee.
So now that you’ve got a good idea of those stocks and bond basics, I want to throw this out to the community, which do you feel is the better investment for your situation? What serves your personal needs best, so scroll down and let me know in the comments.
Understanding How Much to Invest in Stocks and Bonds
Now for the most important part of the video, how much to invest in stocks and bonds, and this isn’t an either-or situation. The answer is much more about finding that perfect mix of stocks AND bonds that gives you the return you need but with less risk so you can sleep at night.
Understanding how much to invest in stocks vs bonds is about understanding how much risk you can tolerate without stressing yourself out and most investors don’t realize, the answer to this changes as you get older.
Younger investors have decades to watch their money grow so a single market crash isn’t going to mean as much over 30 years of investing. They can take that risk with more in stocks and reach for the higher return.
By comparison, investors nearing retirement, safety and preservation of your money is going to be more important. Is it worth maybe another 15% return on your portfolio if you have a 50/50 chance of getting wiped out in the next crash just before you start needing that money to pay the bills? Of course not, so you’d have more in bonds to protect your portfolio. So let’s look through some guidelines for each decade and recommendations for how much to invest in stocks and bonds.
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For investors in their 20s, you’re probably just starting to invest. You’ve got decades ahead of you and maybe not that much invested yet anyway so a drop in stocks wouldn’t amount to much anyway. You’re not going to need that money for a long time so you don’t need the protection in bonds.
So here you might have as much as 80% of your money in stocks and 20% or even less in bonds. That’s going to save some money aside just in case stocks tumble so you can sell your bonds at that point and use the cash to get those stocks at a discount.
Stocks vs Bonds: Are There Other Good Alternatives?
Now the video is stocks vs bonds but in reality, it’s better to break this out into other assets as well, like real estate and alternative investments like cryptocurrencies and crowdfunding. So here instead of just stocks and bonds; you might have 65% of your money in stocks, 10% in bonds, 15% in real estate and 10% in those alternative investments.
That’s going to give you strong returns in stocks and alternative assets along with the cash flow in real estate and bonds.
And I can see some eyes rolling out there, some of you young guns that don’t think you need anything in bonds. TRUST ME, everyone always needs something in bonds…at least 10% of your money to protect you from that what-if scenario where stocks crash or you suddenly need the cash.
As you age into your 30s, your portfolio probably isn’t going to look a lot different but it’s the little shifts that happen over decades that will make the difference. You still have 20 years or more before needing your retirement money so you’ll still have something like 75% of your portfolio in stocks and 25% in bonds or bringing in our other assets; maybe you have 60% in stocks, 10% in bonds, 20% in real estate and 10% in alternative assets, so you see, you’ve taken a little risk off by shifting 5% from stocks into real estate.
In your 40s, you’re getting closer to needing some of your money for college expenses or maybe you just want to finally take that dream vacation. You’re still more than a decade out from retirement though so you want more stocks to give you the return you need to keep growing your money.
Here you might consider holding that college money in a separate account and have more of it in bonds for that safety but generally you’ll want as much as sixty-five or 70% in stocks and the rest in bonds. Using our other assets in the mix, that might look like 55% in stocks, 15% in bonds, 20% in real estate and 10% in alternatives.
And again, just notice we’re gradually reducing our risk and shifting more to safety each decade. This can be an extremely easy investing strategy, just making these small changes every five or ten years to make sure your portfolio is aligned with your age.
In your 50s is where you see the bigger changes. Whether you’re planning on retiring early or not, you’re about a decade out so you can’t afford to see it all wiped out in a stock crash. That’s why we’d have more like 60% in stocks and 40% in bonds or something like 50% in stocks, 15% in bonds, 25% in real estate and that 10% in alternative investments.
In your 60s, you’ll make that final little tweak before retirement and this is when you need the most protection. It’s heartbreaking that into a recession, when stocks crash, I always hear dozens of stories about someone in their 60s, just months from retiring when the market crashes and they end up having to work years longer than expected.
So this is when you really need that protection you get in bonds, maybe even as much as half of your portfolio, so a 50/50 mix of stocks and bonds. Or with our other assets, you might even have less than half in stocks with 40% in stocks, 25% in bonds, 25% in real estate and 10% in those alternatives.
And in retirement. This is the big payoff, right? But while max safety is the goal here, you still need your portfolio to grow a little so it keeps up with inflation and keeps paying the bills. This is 30 or 40 years of your life and prices can double in that amount of time.
That’s going to mean you always want some of your money in stocks for that higher return but you need enough in bonds and cash flow investments to cover the bills so you don’t have to sell your stocks at the wrong time. Here you might consider as much as 30% of your money in stocks with 70% in bonds or something like a mix of 30% stocks, 40% in bonds, 25% in real estate and just 5% or less in those alternative investments.
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About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.