Bonds traditionally provide lower returns than those that come from stocks. However, bonds should still have a great place in your portfolio. There are just so many good reasons to invest some money on bonds. But of course, there are also risks to watch out for. You should also know these risks.
In this article, we will talk about the advantages and disadvantages of investing in bonds. If you’re one of those people who are planning to invest in bonds, this article should help you to decide wisely and properly.
The Advantages
Diversification
Bonds in general sport lower volatility if you are going to compare them side by side with stocks. What does this mean? It means that by using bonds, you can stabilize your portfolio even at times of extreme volatility or market uncertainty.
You should definitely have bonds in your portfolio along with higher yielding but more volatile assets like stocks.
Stability
How do bonds provide stability? Imagine that you know you will need huge sums of money in the near future. If that’s the case, you will be thanking yourself if you have invested in bonds. In addition, it would be a wiser decision to avoid highly volatile markets like the stock and forex market.
Since the bigger portion of the return on bonds comes from interest payments, the volatility or the fluctuation in the price of the bond will just have very small impact on the overall value of your investment.
Consistent Income
Bonds are quite different from dividend stocks, even though the former shares some similarities with the latter. Coupon payments on bonds are consistently sent at regular intervals. If what you want is consistent income, bonds might be a much better investment than dividend stocks and dividend payments, which many stocks do no offer at all.
Tax Benefits
The payments that come from bonds are exempted from federal taxes. For those people who are in the higher tax brackets, bond investments are quite the best financial vehicle for their portfolio.
The Disadvantages
In many cases, bonds are also called “fixed income” investments. However, that may be misleading. They don’t really guarantee a fixed income. Bonds also come with inherent risks, even if they are really much safer investments than stocks. Bonds can still lose their value while you are holding them. Here are some of the most important disadvantages you should never forget about bonds.
Interest Rate
Bond prices are inversely related with the interest rates. If the interest rates increase, bond prices usually go down. The interest rate on a bond is indicated on the day it’s issued. The coupon will then reflect the interest rate of the time of issuance.
Credit Risks
In some instances, people default on their loans and borrowed items. In a similar fashion, organizations that do issue bonds can also default on their obligations. If that’s what’s happening, the remainder of the value of the bond can be lost.
Inflation Risks
Even though there are some exemptions, the interest rates on bonds are set on the day it is issued. And that also goes true for the principal that should be returned on maturity. If there exist a substantial move in the inflation rate over the course of holding the bond, the real value of your investment can certainly take some damage.
