Stocks vs Bonds | How Do Stocks Work?

A stock is a share of ownership in a company; a bond is a loan to a company or government. Stockholders get whatever profit is left after obligations are paid, with no promised return, while bondholders get contractual interest and their money back at maturity, as long as the borrower doesn’t default.

In short: bonds trade upside for priority and predictability. Bondholders are paid first and know in advance what they’re owed. Stockholders are paid last and are owed nothing in particular, but they keep all the growth. That’s why, historically, stocks have earned much higher long-run returns than bonds, with much bigger swings along the way. In US data from 1928 to 2025, large US stocks returned about 10.0% a year compounded, versus about 4.5% for 10-year US Treasury bonds.

Equity vs debt

	Stocks (equity)	Bonds (debt)
What you own	A share of the company	A loan to the issuer
What you’re paid	Dividends if declared, plus any price change	Fixed or set interest (the coupon), plus principal at maturity
Is payment required?	No	Yes; missing it is a default
Upside	Unlimited	Capped at interest plus principal (if held to maturity)
Priority in a failure	Last	Ahead of shareholders
Main risks	Business performance, valuation, market swings	Default, interest rates, inflation
Ends?	No maturity	Matures on a set date

Bonds are issued by governments (US Treasuries, Government of Canada bonds, provincial and municipal bonds) and by companies (corporate bonds). Stocks are only issued by companies. For the ownership side, see what is a stock.

The capital structure

A company’s capital structure is how it is financed: some mix of debt and equity. Lenders accept a lower expected return because they get paid first. Shareholders demand a higher expected return because they absorb losses first.

Debt also magnifies results for shareholders. That effect, called leverage, is the single most useful idea for understanding why stocks are riskier than the bonds of the same company.

A worked example: leverage

Maple Widgets Inc. (hypothetical) has issued $100 million of bonds at 5%, so it owes $5 million of interest every year, whatever happens.

	Good year	Average year	Bad year
Operating profit	$25M	$10M	$4M
Interest to bondholders	$5M	$5M	$5M
Left for shareholders (before tax)	$20M	$5M	-$1M

From the good year to the average year, operating profit falls 60% ($25M to $10M). The amount left for shareholders falls 75% ($20M to $5M). In the bad year, shareholders’ share turns negative, and the company must dip into cash or borrow to pay its bondholders. Bondholders received exactly $5 million in all three years. That’s the trade-off in one table.

How bonds can lose money too

Bonds are not risk-free, even without a default. A bond’s price moves opposite to interest rates: when market rates rise, existing bonds with lower coupons become less attractive and their prices fall.

A worked example. You own a 10-year bond with a $1,000 face value and a 4% annual coupon, paying $40 a year. Market rates for similar bonds jump to 5% right after you buy. A buyer would now pay only what the bond’s payments are worth at 5%:

Present value of ten $40 coupons at 5%: $40 × 7.7217 = $308.87
Present value of the $1,000 principal in 10 years: $1,000 ÷ 1.05^10 = $1,000 ÷ 1.6289 = $613.91
Total: $922.78, a loss of about 7.7%

If you hold to maturity and the issuer pays, you still get every $40 and your $1,000 back. But if you need to sell, or you own a bond fund, the price drop is real. (This uses annual coupons to keep the arithmetic simple.)

That is what happened in 2022, when inflation and rapidly rising interest rates hit both markets at once.

What history shows

The most widely used long-run US dataset, compiled by NYU’s Aswath Damodaran from S&P and Federal Reserve data, covers 1928 to 2025. Annual figures include dividends or interest, before inflation, fees, and taxes:

	S&P 500 (with dividends)	10-year US Treasury bonds	3-month Treasury bills
Compound annual return, 1928-2025	10.02%	4.53%	3.37%
Simple average of annual returns	11.85%	4.82%	3.41%
Standard deviation of annual returns	about 19.4%	about 7.9%	about 3.0%
Years with a negative return (of 98)	26	20	0
Worst year	-43.8% (1931)	-17.8% (2022)
Value of $100 invested at the start of 1928	about $1,157,000	about $7,700	about $2,600

(Standard deviations and counts of negative years are calculated from Damodaran’s annual series.)

The compound and simple averages differ because volatility drags on compounding: a 50% loss followed by a 50% gain averages 0% but leaves you down 25%. The difference between $1.16 million and $7,700 is the power of an extra five or six percentage points a year compounded over 98 years. The arithmetic is in how compound growth works.

Important caveats:

These are US results. The US had one of the best stock-market records of the 20th century. Other countries’ markets did worse, and some suffered total losses.
Before inflation. Real (inflation-adjusted) returns are lower for both.
Long periods hide long droughts. Stocks have gone through stretches of a decade or more with poor returns, as shown in bull and bear markets.

Canadian investors have similar long-run patterns in Canadian stocks and Government of Canada bonds, though the exact figures differ, and Canadian stocks are much more concentrated in financials and resources.

Why both exist in portfolios

Stocks and bonds have often (not always) moved differently. In Damodaran’s data:

2008: the S&P 500 returned -36.6%, while 10-year Treasuries returned +20.1%.
2022: the S&P 500 returned -18.0%, and 10-year Treasuries returned -17.8%, the worst year for those bonds in the dataset.

Calendar years in which both lost money were rare: 1931, 1941, 1969, 2018 (when the bond loss was a tiny fraction of a percent), and 2022. The relationship depends on what’s driving markets. When the fear is recession, high-quality government bonds have tended to cushion stocks. When the problem is inflation and rising rates, both can fall together.

Investors combine the two for different jobs:

Stocks for long-term growth above inflation.
Bonds for income, for money needed in the next few years, and to reduce the swings of a portfolio.
Cash and short-term instruments (Treasury bills, high-interest savings, GICs in Canada) for safety and liquidity. Bank deposits are covered by the FDIC in the US and, for eligible deposits, CDIC in Canada. Stocks and bonds are not.

Holding both is a form of diversification. The right mix depends on time horizon and need for stability, not on predicting which will do better next year.

Preferred shares: the in-between

Preferred shares sit between bonds and common shares: a fixed dividend and priority over common holders, but behind all debt. They are covered in common vs preferred shares.

Credit risk: not all bonds are alike

A government bond in its own currency and a bond from a struggling company are both “bonds,” but they carry very different risks. Rating agencies grade issuers’ ability to repay. Bonds rated BBB- (or Baa3) and above are investment grade; lower-rated bonds are called high-yield or “junk.” Lower-rated borrowers must pay higher interest to attract lenders.

The extra yield isn’t free money; part of it pays for expected defaults. A simple illustration with hypothetical numbers: you hold a diversified basket of high-yield bonds paying 7.5% a year. In a given year, 3% of the issuers default, and you recover 40 cents per dollar on those bonds.

Loss from defaults: 3% × (1 - 0.40) = 3% × 0.60 = 1.8% of the portfolio
Return after losses, ignoring price changes: 7.5% - 1.8% = 5.7%

Compare that with a government bond at, say, 4.0%. The high-yield basket still comes out ahead in this year, but in a recession default rates can jump far above 3%, and high-yield bond prices tend to fall alongside stocks, just when you’d want the bond side of a portfolio to hold up. In Damodaran’s data, Baa-rated US corporate bonds returned about 6.6% a year compounded from 1928 to 2025, between Treasuries and stocks, roughly what the risk ranking would suggest.

What can go wrong

With stocks: deep and long declines, single-company failure, and paying too much for growth that doesn’t arrive.
With bonds: default (especially for lower-rated issuers), price losses when interest rates rise, and inflation eating into fixed payments.
With the mix: assuming bonds always offset stocks. 2022 showed they can fall together.
Reaching for yield: high-yield (“junk”) bonds pay more because they default more, and in a downturn they can behave more like stocks than like Treasuries.

The takeaway

Stocks are ownership with no promised return and last place in line; bonds are loans with contractual payments and priority. Leverage means a company’s shareholders feel every change in profit, while its bondholders get the same coupon in good years and bad. In US data from 1928 to 2025, that extra risk was rewarded with a compound return of about 10% a year for stocks versus about 4.5% for 10-year Treasuries, with far larger swings along the way. Most investors hold both because they do different jobs.