Stocks vs Bonds: What Each Does in a Plan

A stock and a bond do different jobs because they are different legal claims. A share makes you a part-owner paid only what is left after everyone else, with no promised payment and no end date. A bond makes you a lender with a contract for set interest and the return of principal on a set date, unless the issuer defaults. Stocks are the growth part of a plan; bonds handle income, known future bills and stability, depending on which bonds they are.

Key takeaways

Bondholders are paid before shareholders in a bankruptcy, and a company must pay bond interest but need not pay dividends.
In the 24% federal and 5% state brackets, $100,000 in a 4.5% Treasury keeps $3,420 a year after tax; a 3.3% in-state municipal bond keeps $3,300.
In March 2020, Treasury prices rose while Baa corporate bond prices fell.
A bond held to maturity returns a known number of dollars; a bond fund has no maturity date.

What you own: a share vs a bond

A stock is a share of ownership in a company. Its holders profit from a higher share price and from dividends, which a company pays only if it chooses to, and common stock carries a vote at shareholder meetings, according to the SEC's Investor.gov stocks guide. A share has no maturity date: it becomes cash only through a sale or a buyout.

A bond is a loan. The issuer, which may be a company, a state or local government or the US Treasury, promises a specified rate of interest (the coupon) and repayment of the face value at maturity, as the Investor.gov bonds guide explains. The bondholder has no ownership and no vote, and the coupon is the same in good years and bad.

The SEC's bulletin What Are Corporate Bonds? spells out the trade-off. A company in financial difficulty still has a legal obligation to pay bond interest and principal on time, but no similar obligation to pay dividends, and bond investors have priority over shareholders in a bankruptcy. Among bonds, secured bonds come first, then senior and then junior (subordinated) unsecured debt, and banks, suppliers, pensioners and others may have equal or higher claims than some bondholders. Preferred stockholders come next, and common stockholders get whatever is left, which may be nothing.

So the shareholder takes a residual that can grow without limit or fall to zero, and the bondholder gives up the upside for a fixed schedule.

How each pays you and is taxed

A stock pays through dividends, which the board can raise, cut or stop, and through price change. A coupon bond usually pays interest every six months and returns its face value at maturity. The tax rules below come from IRS Publication 550:

Treasury interest is subject to federal income tax but exempt from all state and local income taxes.
Corporate bond interest is taxed as ordinary income, federally and by states with an income tax.
Municipal bond interest on bonds issued by a state, the District of Columbia, a US territory or their political subdivisions is generally free of federal income tax. Some private activity bond interest is taxable or subject to the alternative minimum tax. Municipal interest may also be state-tax-free for residents of the issuing state (Investor.gov). A state may tax interest on another state's bonds.
Qualified dividends are taxed at the long-term capital gains rates of 0%, 15% or 20%. They must come from a US corporation or a qualified foreign corporation, and the shares must be held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. Other dividends are taxed as ordinary income.
Price gains are taxed only when shares are sold, at long-term rates if they were held more than one year (IRS Topic 409). A zero-coupon bond works the other way: its holder generally owes tax each year on interest not yet received.

For 2026, the 24% bracket covers taxable income from $105,700 to $201,775 for single filers and from $211,400 to $403,550 for joint filers, according to the IRS 2026 inflation adjustments. Revenue Procedure 2025-32 sets the 2026 qualified dividend and long-term gain rate at 0% up to $49,450 of taxable income for single filers ($98,900 joint) and 15% up to $545,500 ($613,700 joint). So the whole 24% bracket falls in the 15% band.

Illustrative example: after-tax income from $100,000

Assumed yields, not market quotes: $100,000 in each option for one year, a 24% federal rate, a flat 5% state rate not deducted federally, a home state that exempts its own municipal bonds but taxes other states', and a stock fund yield that is all qualified dividends. The 3.8% net investment income tax is left out; it hits interest and dividends, not municipal interest, above $200,000 of modified adjusted gross income for single filers ($250,000 joint).

Holding (assumed yield)	Income before tax	Federal tax	State tax	Income after tax
Treasury note, 4.5%	$4,500	$1,080	$0 (exempt)	$3,420
Corporate bond, 5.2%	$5,200	$1,248	$260	$3,692
In-state municipal bond, 3.3%	$3,300	$0	$0	$3,300
Out-of-state municipal bond, 3.3%	$3,300	$0	$165	$3,135
Stock fund, 1.5% dividend yield	$1,500	$225 (15%)	$75	$1,200 plus an unknown price change

To compare a tax-exempt yield with a taxable one, convert it to a tax-equivalent yield:

Tax-equivalent yield = tax-free yield / (1 - t)

tax-free yield = the municipal bond's yield (0.033 here)
t              = the tax rate the taxable alternative would pay
                 (0.29 against a corporate bond: 24% federal + 5% state;
                  0.24 against a Treasury, which is state-exempt)

Against the corporate bond, 3.3% / 0.71 = 4.65%, below 5.2%. Against the Treasury, 3.3% / 0.76 = 4.34%, below 4.5%. At these yields the in-state municipal bond keeps the least of the three bond types. It would match the Treasury at a federal rate of about 26.7% (1 − 3.3/4.5) and the corporate bond at a federal rate of about 31.5% (with the 5% state tax), so it comes out ahead of both only from the 32% bracket up. The corporate bond's extra $272 a year is pay for credit risk the Treasury holder does not carry.

The stock fund's $1,200 is the smallest figure because most of its return, or loss, comes through price, which nobody knows in advance.

What can go wrong with each

The bond risks below are the ones the SEC lists in its corporate bond bulletin. For stocks, Investor.gov notes that large-company stocks as a group have lost money in about one year out of every three.

Risk	Stocks	Bonds
Business failure	The main risk. Common holders are last in line and can lose everything.	Credit risk: missed interest or principal. Very low for Treasuries.
Price swings	Prices react to company news and outside events.	Interest-rate risk: prices fall when rates rise, Treasuries included. A loss is realized only on a sale before maturity.
Inflation	No contractual link to prices. Earnings and dividends may or may not keep up.	Fixed payments buy less as prices rise, except with TIPS and I bonds.
Payments cut or ended early	Dividends can be cut or suspended without any default.	Call risk: the issuer may repay early, often after rates fall, leaving reinvestment at lower yields.
Selling when needed	Listed shares usually trade throughout market hours.	Liquidity risk: some bonds trade rarely.

Inflation-linked bonds

At 3% annual inflation, $10,000 of principal returned after five years buys what about $8,626 buys today. The Treasury sells two hedges.

TIPS come in 5-, 10- and 30-year terms. Their principal rises and falls with the Consumer Price Index, interest is paid every six months on the adjusted principal, and at maturity the holder never gets less than the original principal.

I bonds combine a fixed rate with an inflation rate that resets every six months. Bonds issued from May 1 to October 31, 2026 earn 4.26% for their first six months, including a 0.90% fixed rate kept for the life of the bond. A new rate applies to purchases from November 1, 2026.

Both are taxed federally but not by states, on different timing. In a taxable account, each year's increase in a TIPS principal is federally taxable that year even though it is paid only at maturity, according to Pub 550. I bond interest is paid at redemption, and cash-method taxpayers can choose to report it then rather than each year.

The jobs each can do in a plan

Growth: stocks. Investor.gov says stocks offer the greatest potential for growth over the long haul. That holds for long horizons and fails when money must be withdrawn at a low point.
Income: bonds, and dividend stocks with caveats. Coupons are contractual; dividends can be cut. Bond income is predictable in dollars, not in buying power.
Liability matching: individual bonds. A Treasury maturing shortly before a known bill, such as tuition, delivers a known sum on a known date. Stocks have no maturity and no promised value.
Ballast: high-quality bonds. The steadying effect depends on credit quality.

March 2020: Treasuries and corporates split

From February 19 to March 23, 2020, the S&P 500 index fell from 3,386.15 to 2,237.40, a 33.9% drop. Meanwhile the 10-year Treasury yield fell from 1.56% to 0.76%, so existing Treasury prices rose.

The Moody's Baa corporate yield rose from 3.61% to 5.07%, so prices of lower-investment-grade corporate bonds fell, and the Baa-Treasury spread more than doubled, from 2.05 to 4.31 percentage points. On March 23 the Federal Reserve announced two facilities to support corporate bond markets. Treasuries did the ballast job and Baa corporates did not. This is one episode, not a rule; the stock-bond relationship has shifted in other periods.

Individual bonds vs bond funds

A bond fund keeps buying and selling bonds, so no date brings principal back. FINRA's predecessor, the NASD, warned in Notice to Members 04-30 that a bond fund does not guarantee the return of principal because its net asset value fluctuates, and that it carries ongoing fees and expenses. In exchange, a fund spreads credit risk across many issuers and can be sold on any business day.

Illustrative example: known schedule vs unknown path

Assume $10,000 in a new 5-year Treasury note with a 4.5% coupon and $10,000 in a stock fund yielding 1.5% (illustrative figures, not quotes or forecasts).

Year	Treasury note cash flows	Stock fund cash flows
1–4	$225 every six months ($450 a year)	About $150 a year if the payout is unchanged; not promised
5	$450 interest plus $10,000 principal	About $150, plus whatever the shares sell for that day
Total over 5 years	$12,250, known at purchase (barring default)	Unknown at purchase; could be far above or below $10,000

The note's $12,250 is fixed in dollars. Discounted at 3% annual inflation, those payments are worth about $10,702 in today's money. The stock fund's result depends on the price on the day it is sold, which is why it suits goals whose timing can move.

Buying each and what it costs

Stocks can be bought through a broker, a company's direct stock plan or dividend reinvestment plan, or a stock fund (Investor.gov). Funds charge ongoing expenses out of fund assets.

New Treasuries, including TIPS, can be bought at auction through TreasuryDirect from $100, in $100 steps, using noncompetitive bids that accept the auction yield. They must be held at least 45 calendar days before being transferred or sold. Banks and brokers also sell Treasuries. I bonds are limited to $10,000 per person per calendar year.

Corporate and municipal bonds usually trade over the counter, with the dealer's markup built into the price. Since May 14, 2018, FINRA Rule 2232 and MSRB Rule G-15 have required the markup to appear on a retail customer's confirmation, in dollars and as a percentage of the prevailing market price, when the firm made offsetting principal trades in the same bond that day. Retail confirmations also show the execution time and a link to public trade data (FINRA). Municipal bond documents and trade prices are free on the MSRB's EMMA site.

Frequently asked questions

Can a Treasury lose money?

Yes, if it is sold before maturity after rates have risen. Held to maturity, it pays its face value and every coupon, backed by the full faith and credit of the US government.

Is preferred stock closer to a stock or a bond?

It sits between them. Preferred holders usually have no vote, receive dividends before common holders and rank ahead of common stock in a liquidation, but behind bondholders, according to Investor.gov. If preferred dividends cover periods totaling more than 366 days, the shares must be held more than 90 days within a 181-day window for those dividends to count as qualified.

Does tax-exempt municipal interest go on a tax return?

Yes. It appears on Form 1099-INT, box 8, or as exempt-interest dividends from a fund on Form 1099-DIV, box 12, and the total goes on Form 1040, line 2a, even though it is not taxed federally. Amounts in Form 1099-INT box 9 or Form 1099-DIV box 13 are the part that may be subject to the alternative minimum tax.

When can I bonds be cashed in?

Not during the first 12 months. Cashing in before five years forfeits the last three months of interest, so a bond redeemed at 18 months earns 15 months of interest. An I bond earns interest for up to 30 years, according to TreasuryDirect.

Why does a stock fund pay out capital gains?

When a fund sells holdings at a profit, it generally passes the gains on as capital gain distributions, taxable in a taxable account even if the shareholder sold nothing. Pub 550 says they appear in Form 1099-DIV, box 2a, and are reported as long-term gains however long the fund shares were held.

Questions to settle before buying

Name the job: growth, income, a known future payment or stability.
For any bond, check the issuer, rating, maturity, call terms and seniority in the offering documents or on EMMA.
For a bill due on a set date, weigh an individual bond maturing before it against a bond fund.
Run the tax-equivalent yield at your own federal and state rates; tax-deferred accounts change the answer.
Read the markup on a bond confirmation and a fund's expense ratio before comparing yields.