Advantages of Bonds Investment

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Advantages of Bonds Investment

Bonds have been an investment option for new and advanced investors for as long as 2400 BC, so they have a long, decorated history that has lasted the test of time, as they’re still invested in today.

This means that they must hold some value for you as an investor, right? Yes, of course, but are they what you should invest all your money in? Probably not.

That’s why, in today’s article, we’re going to look at the advantages of bonds investment, along with some cons too. This way, you can gain a deeper understanding of whether or not they suit your situation and if you should take the leap with bonds today or hold off.

 

Pros of Investing in Bonds

If you’ve done some research on bond investing, you will know that bonds are used to diversify portfolios from just owning traditional stocks. Yet, whether this is beneficial to the investor will all depend on their goals, interest rates, and overall risk tolerance for the market. Let’s take a look at some of the broad pros of investing in bonds for your investment strategy.

 

1. A Safer Space For Your Money

While the stock market typically returns more in interest than bond investments over a long period of time, they are often a lot less volatile than stocks or index funds.

This is because the stock market index goes up and down based on the economy’s performance, so if something such as the 2007–2008 financial crisis were to happen again, you’d have nothing to do but see your invested money crash.

However, with bonds, you are almost certainly guaranteed to gain reliable returns through coupon payments (interest rate payments). Plus, they’re backed by the government and are a form of debt. Investing in debt is often less risky than investing in equity.

 

2. You Have More Predictable, Regular Returns

Although the stock market index will outperform bonds in the long term if you begin ‘dollar cost averaging’ (investing a fixed amount on a regular basis, regardless of the share price), bonds will be more predictable even in times of financial crisis within the economy.

Therefore, if your risk tolerance is low, you’re coming up to retirement but still want to be investing, and you just genuinely want safe, steady returns, making up some of your portfolios with bonds will give you the security you desire.

This is because you can almost guarantee the amount of money you will yield with bond investing based on coupon payments, along with the yield percentage.

So, suppose you’re a retiree or coming up to retirement and need a degree of certainty within your portfolio. In that case, bonds should make up a larger portion of your portfolio compared to, let’s say, a 20-year-old with their life ahead of them who can afford to dollar-cost-average through a potential financial crisis.

 

3. Better Returns Than Most Expect

If you have spare money to invest and don’t want it just sitting there, bonds can often yield higher returns than your bank and savings accounts. This can be great if you don’t need the money for the next 1-3 years and want it to grow with almost guaranteed returns.

Of course, you should do your due diligence and find the best bond investment for you, whether that be corporate bonds, government bonds, bond funds, and many more. Also, you may want to compare it to some high-yield savings accounts because these can sometimes offer better returns.

Yet, if you find a bond that suits your needs with a maturity date that works for you, there is no harm in investing in that bond and obtaining steady rates of income.

 

Are There Any Downsides to Bonds Investment?

There are always advantages and disadvantages to every type of investment you will make in your lifetime, but to ensure that you understand the cons and can weigh up what you’re willing to sacrifice for the advantages of bond investment, we’re going to break them down here.

 

Bonds May Not Keep Up With Inflation

Depending on the bond investment you make, if you choose a maturity date that is close to when you start investing, the yield of returns will often be lower. Whereas, if you choose a maturity date that is further down the line, you’re often guaranteed higher interest payments.

Yet, no matter the maturity date, if your bond doesn’t yield high enough returns, the yield of inflation can sometimes overtake the yield of returns. This essentially means that even if your money looks like it is going up, inflation may be growing faster, leaving you with negative returns.

(Here’s a simple example to make it easier to understand:) I invest in a bond that yields 3% a year, but the inflation rate is 3.2% a year, meaning I’d actually be losing out on 0.2% a year in returns due to inflation.

This is not the case always, though, as bonds typically have an average return of between 4-5% a year.

 

Bonds Suffer When Interest Rates Rise

If you purchased a bond a long time ago when interest rates were low, then that bond will often have a high yield, and you’ll see safe returns. Yet, if the interest rates rise, the price of your bonds will fall because there will be new bonds on the market with higher coupon/interest rates.

This means that all investors will have an incentive to buy the new ones, decreasing the value of the ones at the previous interest rate. Here’s a visual example below for those who may understand it better that way:

Bonds cycle when interest rates rise

 

Bond Issuer Could Go Bankrupt

All investments have risks involved and a bond is no different. This rarely happens but a ‘call risk’ is the chance of your bond’s term being cut short by the bond issuer. Sometimes, there have been cases where the issuer is not able to meet the financial obligations and the bond investor hasn’t received their promised coupon payments.

In the odd case that this happens, you can either sell your bond and put your money elsewhere, or hold on to it if you trust that your payments will return to normal.

 

Should You Invest in Bonds?

In relation to whether or not you should invest in bonds and have them in your portfolio, that is not our investment decision to make. If you’re an investor who wants little to no risk while providing steady returns or an upcoming retiree (or already retired), we would recommend you invest in bonds.

However, if you’re a young investor looking to begin investing, we believe that index funds and the stock market should be something you do more research on and invest in, as they often provide better returns over time.

Yet, once again, if you want to be a steady, low-risk investor from a young age until retirement, bonds are worth adding to your portfolio, as they will provide you with a steady stream of income, help you build savings, and help you grow your wealth.

Are you searching for investments which outperform bank interest rates?​

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