Bonds vs equities

Where should income-seekers turn?

If you’re weighing up making an investment designed to generate income, Oliver Stone, Fairstone Head of Portfolio Management looks at the advantages and risks of two major asset classes: bonds and equities.

UK income-seekers have many options when investing for income, with bonds and equities often providing the foundation of a portfolio. Both asset classes have their unique advantages and risks.

As with any investment decision, it’s essential to understand the differences between the two and assess your risk tolerance, investment goals and time horizon.

Bonds

Bonds are fixed-income securities that governments, corporations or other entities issue to raise capital. They pay periodic interest (coupon) to bondholders and return the principal amount upon maturity.

Some key features of bonds include:

Potential for lower risk and stability: Bonds are generally considered less risky than equities because they can provide a regular income and a predetermined return on investment. Historically their price fluctuations have been significantly less volatile than those of equities, though as 2022 showed, that is not guaranteed to always be the case.

Predictable income: Bonds provide a predictable income stream through coupon payments, making them attractive for income-seeking investors.

Diversification benefits: history suggests that particularly government bonds can help to balance the volatility associated with equities in a portfolio, especially in times of turmoil, where those bonds from the most creditworthy issuers have tended to hold up better than equities.

However, there are some risks associated with bonds:

Lower long-term returns: Looking back over a long time frame, bonds typically offer lower returns than equities due to their lower risk profile and more predictable return profile.

Interest rate sensitivity: Bond prices are sensitive to interest rate changes, and rising rates can lead to capital losses.

Inflation risk: Inflation can also lead to rising interest rate expectations which can lead to capital losses, while also eroding the purchasing power of bond income, making it less attractive over time.

Credit risk: an issuer’s financial health can impact its ability to make timely interest payments and return the principal at maturity.  

Equities

Equities, or stocks, represent ownership in a company. You can benefit from the company’s growth and profitability as a shareholder.

Some advantages of equities include:

Higher long-term returns: Equities have historically provided higher long-term returns compared to bonds, making them more suitable for investors seeking capital appreciation.

Dividend income: Many companies pay dividends to shareholders, providing a source of income. Importantly this source of income can growth significantly over time.

Inflation hedge: Some equity investments can potentially outpace inflation over time, preserving the purchasing power of your investments.

On the other hand, equities come with their own set of risks:

Higher volatility: Equities can experience significant price fluctuations, leading to higher potential returns but also losses in periods of wider market volatility.

Company-specific risks: The performance of individual companies can significantly impact your investment, making stock selection crucial.

Diversified portfolio containing both bonds and equities

For UK income-seekers, diversification across asset classes is of paramount importance, and determining an appropriate mix of assets within your portfolio depends on your individual goals, risk tolerance and investment horizon. A higher allocation to bonds may be appropriate if you prioritise stability and predictable income. However, a higher weighting to equities could be more suitable if you’re willing to accept a higher level of risk within your portfolios.

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THIS ARTICLE DOES NOT CONSTITUTE TAX OR LEGAL ADVICE AND SHOULD NOT BE RELIED UPON AS SUCH.

THE VALUE OF YOUR INVESTMENTS CAN GO DOWN AS WELL AS UP, AND YOU MAY GET BACK LESS THAN YOU INVESTED.

THE TAX TREATMENT IS DEPENDENT ON INDIVIDUAL CIRCUMSTANCES AND MAY BE SUBJECT TO CHANGE IN FUTURE. FOR GUIDANCE, SEEK PROFESSIONAL ADVICE.