The prices of bonds and stocks move in the opposite directions. When stocks go up in value, bonds go down. This is because stocks generally do well when the economy is booming. Consumers are buying and companies receive higher earnings thanks to higher demand. Investors want to take advantage of higher stock prices. so they sell their bonds and buy stocks.

Conversely, when the economy slows, consumers buy less, corporate profits fall, and stock prices will dip. This is when investors want the steady interest payments guaranteed by bonds.

However, sometimes both stocks and bonds go up in value at the same time. This is usually because there is too much money. or liquidity. chasing too few investments, as is the case at the top of a market. It could also be the case when some investors are optimistic about the economy’s future, and buying stocks. while others are pessimistic and buying bonds .

There are also times when stock and bonds both fall. That’s when investors are in a panic, and are selling everything. During those times, you might see gold prices go up.

Bonds vs Stocks

Whether bonds or stocks are a better investment depends on two things. First, what are your personal goals? If you want to avoid losing your principal, enjoy receiving regular payments, and aren’t concerned about inflation. then bonds are for you. That might be the case if you are retired, or otherwise need to use the investment income .

If, on the other hand, you can hold onto your stocks even if the value drops, you don’t need income, and want to outpace inflation, then stocks offer more benefits. If you’re young and have a well-paying job, then that would describe your situation.

Second, how is the economy doing? In other words, what phase of the business cycle is it in? If it’s expanding, then stocks provide more benefits because they are gaining value as earnings improve. If it’s contracting, then bonds are a better investment, because they will protect your investment while providing income. Here’s where we are in the current business cycle .

Most financial planners will tell you that the best investment strategy is to be well-diversified. That means have some stocks and some bonds in your portfolio at all times. Research has shown that, over time, diversification brings the greatest return at the lowest risk.

You can change the mix, or asset allocation. of stocks vs bonds to respond to the business cycle and your financial goals. However, having some of each protects you from the unknown.

How the Federal Reserve Uses Bonds to Boost the Stock Market

The Federal Reserve controls interest rates through its open market operations. When the Fed wants interest rates to fall, it buys U.S. Treasuries. This is the same as increasing demand for the nation’s bonds, which makes their values rise. As with all bonds, when the value rises, interest rates fall.

Lower interest rates put upward pressure on stock prices for two reasons. First, bond buyers will now get a lower interest rate, and therefore return, on their purchases. This forces them to consider buying stocks to get a higher return, even though they are riskier.

Second, lower interest rates make borrowing less expensive. This helps companies who want to expand, homeowners who want to buy new houses, and consumers who want to take out low-cost loans to buy cars, furniture and even go back to school. As a result, low interest rates boost economic growth, which leads to higher corporate earnings and higher stock prices. Article updated September 4, 2014