What's the difference between stocks and bonds?

A stock (or share) makes you a part-owner of a company. A bond makes you a lender to it. Almost every other difference between them follows from that.

As an owner, you share in the company's profits, through dividends if it pays them and through a rising share price if the business grows. There's no cap on how far a share can rise, but you can also lose everything you put in. As a lender, you're promised a fixed rate of interest (the coupon) and your money back at the end (maturity). You don't share in the upside, but you're paid before the owners if things go wrong.

A worked example

Imagine you put $10,000 into the same hypothetical company two ways:

	Stock	Bond
What you are	Part-owner	Lender
What you're promised	Nothing fixed	5% a year, then your $10,000 back
If the company thrives	Your shares could be worth $20,000, or far more	You still get $500 a year and your $10,000
If the company fails	Shares are often worth nothing	You're ahead of shareholders in the queue for whatever's left

The bond's best case is known on day one. The stock's isn't, in either direction.

Who gets paid first

When a company goes bust, its assets are paid out in a fixed order, sometimes called the repayment waterfall:

1. Secured creditors, such as banks holding collateral
2. Unsecured bondholders
3. Preference shareholders
4. Ordinary (common) shareholders

Ordinary shareholders sit at the bottom. They absorb losses first and are repaid last, and in an insolvency they frequently get nothing.

Why stocks are expected to earn more

Nobody would accept being last in line without being paid for it. That's why stocks are expected to earn more than bonds over the long run, with more ups and downs along the way. The extra return investors expect for owning shares instead of near-risk-free assets is called the equity risk premium. In developed markets it has historically averaged roughly 4-6% a year, though estimates vary with the period and method used.

Not all bonds are equally safe, either. Rough order from lowest risk and return to highest:

• Cash and cash equivalents: money market funds, short-term government bonds
• Investment-grade bonds: a little more return, modest risk of default
• High-yield ("junk") bonds: higher coupons, real default risk
• Stocks: higher long-run expected returns, much bigger year-to-year swings

Which is "better"?

Neither. They do different jobs. Stocks are the growth engine; bonds are steadier and pay a predictable income. Many portfolios hold both, in proportions that depend on how long the money can stay invested and how much of a fall you could live with.

Learn it properly

Finance Brain's Equity vs Debt Instruments lesson, in the Investment Classes course, covers capital structure, the repayment waterfall and the full risk/return spectrum, including where alternative investments such as private equity and venture capital fit. It ends with a short quiz.

Finance Brain is educational content, not financial advice.