When bond yields are high, that can make newly purchased bonds more attractive for income—but it does not automatically make bonds a better investment than stocks. Choose based on when you need the money, how much volatility you can tolerate, and the role each asset should play in your portfolio. A bond’s yield is only one part of its risk and potential return.
What stocks and bonds do in a portfolio
Stocks represent ownership in companies. Their prices can rise or fall with company prospects and market conditions, and they offer potential for long-term growth alongside the possibility of substantial losses.
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Bonds are loans to governments or companies. Their terms specify interest and repayment of principal, but payment depends on the issuer meeting its obligations. Bond prices also move with market rates, and some bonds may be difficult to sell at a predictable price.
The choice is not necessarily one or the other. A portfolio can hold both, with the mix reflecting its purpose and the investor’s circumstances.
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How to compare stocks and bonds
| Decision factor | Stocks | Bonds | Question to ask |
|---|---|---|---|
| Portfolio role | Ownership exposure and potential growth, with market-price volatility. | Interest and principal terms, subject to issuer performance and market risks. | Is the goal long-term growth, planned income, or a combination? |
| Time horizon | A price decline may be difficult to absorb if the money is needed soon. | Maturity or fund duration can be considered alongside when the money may be needed; selling early exposes the investor to price changes. | When will you use the money, and can you wait through a downturn? |
| Rate sensitivity | Higher rates can weigh on stock values, including by increasing companies’ borrowing costs. | Prices of existing fixed-rate bonds generally fall when market rates rise; maturity and duration affect sensitivity. | How much interim price movement can you tolerate? |
| Credit and business risk | Shareholders face business and valuation risk. | Bondholders face issuer credit and default risk; lower-rated debt usually offers higher yields to compensate. | Is added yield worth the possibility of missed payments or loss? |
| Liquidity and sale timing | Liquidity depends on the security and market. | Some bonds trade infrequently, making a sale price harder to establish. | Could you need to sell before your intended horizon? |
| Diversification | Exposure can be spread across issuers and sectors. | Exposure can be spread across issuers, maturities, and Treasury, corporate, or municipal bonds. | Is your exposure spread across and within asset categories? |
The SEC’s Office of Investor Education and Advocacy summarizes the key fixed-rate bond relationship: “When market interest rates rise, prices of fixed-rate bonds fall.” (SEC Investor Bulletin, June 26, 2013.)
Why a bond’s price moves when rates change
A fixed-rate bond’s coupon does not change when market yields do. If new bonds offer higher rates, an older bond with a lower coupon generally has to fall in price to offer a competitive yield to a new buyer. If market rates fall, an older bond with a higher coupon generally becomes more valuable.
The SEC illustrates the relationship with a hypothetical 10-year Treasury bearing a 3% coupon: it is shown at $1,000 when market rates are 3%; after market rates fall to 2% and one year passes, it is shown at $1,082 with nine years remaining. In a separate rising-rate example, a 3% coupon bond is shown at $925 after market rates rise to 4%. These are educational illustrations, not current prices or forecasts. (SEC Investor Bulletin.)
Longer maturity and lower coupon generally mean greater sensitivity to rate changes. Duration is a measure investors can use to assess that sensitivity; it is not a forecast of a bond’s return. (FINRA, Bonds.)
What a high yield does—and does not—tell you
A high starting yield can improve the income available from newly purchased bonds, but it does not guarantee a high total return. The yield alone also cannot show whether a bond’s risks suit your needs. Compare it with the bond’s maturity or duration, credit quality, liquidity, call terms, and the possibility that you will need to sell before maturity.
High-yield corporate bonds offer higher rates in exchange for greater credit and default risk. That higher yield does not make them equivalent to higher-quality bonds. (SEC Investor.gov, What Are High-Yield Corporate Bonds?)
For a U.S. rate reference, the Treasury’s daily par yield curve is based on indicative closing bid quotations for recently auctioned securities and interpolated at constant maturities. A constant-maturity figure is not necessarily the yield available on a particular bond, and Treasury rates are bond-equivalent yields rather than effective annual yields. A dated maturity-specific rate is more informative than referring to one number as “the bond yield.” (U.S. Treasury, Interest Rate Statistics; U.S. Treasury, Interest Rates — Frequently Asked Questions.)
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Individual bonds and bond funds are not interchangeable
Individual bonds
If you hold an individual bond to maturity and the issuer pays as promised, interim market-price swings may matter less than they would if you had to sell. Holding to maturity does not remove default risk. Selling before maturity can realize a gain or loss, and a bond’s market price may be difficult to establish if it trades infrequently.
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Bond funds
A bond fund does not give an investor one individual bond’s maturity date to hold through. The fund’s value fluctuates with its holdings and market conditions; its portfolio can carry interest-rate, credit, and prepayment risks. Review the fund’s holdings, fees, and prospectus risk disclosures rather than treating its yield as a complete description of the investment. (SEC Investor.gov, Bond Funds and Income Funds.)
Choose a mix by goal, horizon, and risk tolerance
- Name the goal and date. Decide what the money is for and when you expect to use it. A goal that is approaching can make reducing risk more important, even if that means accepting lower potential growth.
- Assess your tolerance for loss and volatility. Consider whether you could stay with your plan through a market decline without selling in response to fear. Your time horizon and capacity to bear losses both matter.
- Evaluate any bond exposure beyond its yield. Check maturity or duration, credit quality, liquidity, call terms, and whether you might need to sell early. Do not take on a risk just to pursue a higher stated yield.
- Diversify across and within asset categories. Broadly diversified funds can simplify exposure, but they still carry risks and fees. Diversification can help manage portfolio risk; it does not guarantee a profit or prevent losses.
- Review and rebalance when circumstances or targets change. Rebalancing can bring a portfolio back toward its intended allocation; it does not require trying to predict which asset will win next. (SEC Investor.gov, Beginners’ Guide to Asset Allocation, Diversification, and Rebalancing.)
There is no universal stock-and-bond percentage that fits every investor. The appropriate allocation depends on the goal, time horizon, risk tolerance, and the investments’ role in the broader portfolio. This is general investor education, not an individualized allocation recommendation.
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