Stocks Vs. Bonds: Which Is The Better Investment?

Key takeaways

• The stock market has performed well in 2023, with the S&P 500 up 9% so far
• Bond yields recently had their biggest one-day decline since 1987 – two-year Treasury yields are hovering at roughly 4.1%
• A diversified portfolio is the best option ahead of recession fears – helped by AI investing to do the hard work for you

An upcoming recession is all anyone can talk about right now. As we face the prospect of higher interest rates and inflation stays stubbornly persistent, it can be hard to know which asset class is best for your portfolio.

The most common investments are stocks and bonds. But what’s the difference between the two, and which is the best investment for 2023? Let’s take a look at what stocks and bonds are, what’s been happening in the market lately and which is better to weather any financial storms.

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Stocks vs. bonds 101

If you’re new to investing, you might wonder what stocks and bonds are (don’t worry, we’re not judging). Before we get started, it’s helpful to understand the differences between the two.

Stocks

The stock market comprises different publicly traded companies, where you can buy partial ownership of the company in the form of shares. These can rise or fall in value depending on how well the company performs, macroeconomic headwinds and other market conditions. Stockholders may get quarterly or yearly dividends, which are company profits handed back to shareholders.

The stock market can be pretty volatile at times, and investing in individual companies generally isn’t recommended so you don’t have ‘all of your eggs in one basket.’

Bonds

Bonds are when investors lend money to the issuer, usually a government, with the agreement that they’ll pay back the loan with interest (or yield rate) and return the original amount when the bond reaches its maturity date.

Bond yields (income) and prices go in opposite directions. So in times of economic uncertainty bond yields can fall as prices rise, as investors look to safer investment options – because the theory is the government won’t default on the loan.

What’s the latest in the stocks and bonds market?

Both markets are sensitive to economic conditions in different ways. So far this year, stocks have been rallying while bonds have been more volatile than in previous years.

One key factor has been inflation, which is still dominating financial news headlines and leaving investors in a cold sweat. That’s because high inflation is never good news for the market: it makes borrowing more expensive and pressures consumer spending. This, in turn, leaves companies holding the bag. We’re seeing it now with mass layoffs and the so-called ‘year of efficiency’ at Meta, which Wall Street has largely rewarded Big Tech for doing.

As for bonds, high inflation makes them a less attractive investment option as they don’t have as much future purchasing power. That’s combined by the fact that when the Fed raises interest rates, it makes existing bonds with lower rates less attractive, which drives down their prices. This pushes up the yields, like on ten-year Treasury bonds, which is an important temperature gauge for the economy’s health.

Another interesting time for the markets was March’s banking turmoil, where three banks collapsed. Stocks went up in value despite the crisis, with the S&P 500 posting a 7% gain for the quarter, and the Nasdaq shot up over 16% at the same time. That’s more indicative of the better-than-expected economic data coming out that month; otherwise, stocks would likely have moved down at the sight of financial doom and gloom.

The bonds market saw its biggest rally since 1987 after the banking crisis. Yep, you read that right. It’s because the banking crisis sparked further fears of economic instability, so traders started buying bonds and inspired others to join in. In March, short-term Treasury yields hit 5% for the first time since 2007, then plunged down to 4.030% in its biggest one-day decline for decades.

That’s some serious volatility that is unusual for the bond markets. Today, the yield is around 4.1% for two-year Treasury bonds and roughly 3.57% for ten-year Treasury bonds.

Stocks or bonds: which is better?

As fears of a recession by the end of the year grow, the Fed is now predicting we’ll see a mild recession with a two-year recovery. As we await the Fed’s decision on interest rate rises and the likely outcome for the rest of the year, it’s pretty difficult to tell whether stocks or bonds are the best bet for traders.

Some parts of the stock market, like flashy tech stocks, tend to decline during recessions because they rely on future valuations. But there are still ways to recession-proof a stocks-heavy portfolio, like investing in ‘recession-proof’ stocks. These companies are always in demand, like consumer staples and utilities, with steady returns over the years. It’s not as exciting as a buzzy new stock going to the moon, but it’s a safe strategy to see you through leaner times.

If we’re looking at bonds, investors tend to flock to these during recessions as they’re seen as ‘safe haven’ investments. It’s worth looking into buying bonds if you don’t have any exposure in your portfolio, but beware: bonds saw a 13% decrease in value last year. Paired with the 18% S&P 500 loss, it was the first time the two markets had double-digit losses since 1969.

But there’s a third option that makes a lot of sense, whether it’s a recession or not, and that’s diversification. Investing in a mix of stocks and bonds and taking a long-term view of the investing road ahead can pay off—literally. As for which is better, that depends on your personal risk threshold and the make-up of your portfolio.

The bottom line

Both stocks and bonds are performing better than they did last year, but in 2023 the stock market has further to fall as it continues to resist the growing concerns around a recession. The best tactic is to diversify your portfolio so you’re not overly reliant on one or the other doing well.

Bonds are swinging about and suffered an unusually bad return last year. With stocks, trying to time the market doesn’t usually go well and puts a lot of work on the trader to keep up with the latest data. So naturally, we’d recommend AI investing as your new go-to tool for recession-proofing your portfolio.

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Download Q.ai today for access to AI-powered investment strategies.