Investment Diversification

Whether you’re an experienced investor or just starting out, you’ve probably heard the saying, “don’t put all your eggs in one basket.”

In the investment world, that phrase is often used to encourage investors to divide their portfolio holdings between a mix of stocks and bonds. Why? Because those two asset classes have differences that have tended to complement each other quite well.

 

First, Let’s Talk about Stocks

Stocks, also known as equities, are issued by companies to raise capital to undertake new projects or grow business. When you invest in stocks, you're buying a share of a public company’s earnings.

The faster those earnings grow, the greater the potential for appreciation in the price of the stock. Conversely, declining earnings tend to cause the price of the stock to decline.

So How Are Bonds Different than Stocks?

Bonds are different from stocks in a few ways. First, bonds are loans that investors make to corporations and governments. The lenders earn interest, and the borrowers get the cash they need.

Second, bond holders are entitled to repayment of principal. Corporate bond holders also have priority over equity shareholders should the company go bankrupt. Primarily for this reason, stocks are typically considered to be a riskier asset class than bonds.

However, bond holders are only entitled to receive the return given by the interest rate agreed upon by the bond. In contrast, stocks give shareholders the potential for higher or lower returns based on several factors, including corporate earnings, and the stock market’s view of whether those earnings are likely to be higher or lower in the future.

Putting It All together

Most investment experts suggest investors have a diversified portfolio with a mix of stocks and bonds, and even a mix of corporate and government bonds. Though exactly how much of each to own generally varies with an individual investor’s goals, risk tolerance and investment timeline.