Certain investors consider bonds a safer investment in comparison to more traditional forms of financial instruments like stocks or managed funds. However this is not always true. While bonds are definitely less risky when managed efficiently, with poor management investing in bonds, can be the reason for wiping out your entire portfolio.
The US bond market has various forms of bonds available for investment. Some of the most common variety of bonds issued in the market are US government securities, municipal bonds, corporate bonds, mortgage and asset backed bonds, federal agency securities and foreign government bonds. Bond investments can also be issued in the forms of bills, notes, debt obligations and debt securities. Listed below are some of the important facts about investing in bonds which investors need to know prior to considering investing in them.
Long Term Bond Investment Tips
- Bonds Can Be Considered I.O.Us: Bonds are a way to fund specific operations or projects be it in the public or the private sector. When government agencies or large corporations want to raise secured finance, they do so by issuing bonds in the primary market and as a result are known as issuers. When individuals purchase these bonds, they become bond holders and as a result of which own secured credit.
- Stocks Vs Bonds: For long it has been a misconception that stocks outperform bond investments owing to the fact that stocks are seen as more volatile and hence are considered to return greater value to their investors. However long term moving averages when compared would disagree. It is only in the post World War II era that stocks have outperformed bonds. Between the years 1870 to 1940 both stocks and bonds had early the same returns. However in the bond market of 2001-2003 bonds once again over took stocks. Although stocks did better in between 2004 and 2007 by the year 2008 bonds once again had taken over.
- Investing In Bonds Can Cause You To Lose Money: The age old saying that bonds are the safest investments on the market may not hold as much water as it once did. As seasoned institutional investors will testify, bond investments can cause you to lose money if not managed efficiently. While investing in bonds represent fixed interest investments, because of their fixed life span and fixed interest payments, the returns a bond may generate may vary and may also sometimes be negative causing you to lose money.
- Bond Prices Are Negatively Related To Interest Rates: With the rise in interest rates in the market bond prices will fall and vice versa. However for an investor who is going to hold his or her bond investment to maturity, interest rate fluctuations do not matter as the investor will get back the face value of the bond upon maturity plus all the interest payments over the life of the bond.
- Bonds and Mutual Funds Are Mutually Exclusive: Investors often confuse bonds and mutual funds. With a bond investment, investors have the guarantee that they will receive the face value of the bond upon maturity plus all the interest payments over the life of the bond, unless the issuer goes bankrupt. However in the case of a mutual fund the return an individual investor can expect is uncertain owing to the fact that the actual value of the mutual fund fluctuates.
- Tax-Free Bonds: While tax free bonds might yield less that taxed bonds, it might be prudent to hold certain tax-free municipal bonds depending upon the tax bracket you fall under. For example if you are in the 28% federal tax bracket it would be better to hold tax-free bonds owing to the fact that they will net you more in comparison to taxed bonds after tax.
- Invest Long Term In Bonds: A very common issue with investing in bonds is the time factor. A lot of investors sell their bond investments prior to maturity and as a result of which may sometimes experience very little capital gains or in certain cases capital losses. However investors who can hold their bond investment till maturity need not worry about interest rate fluctuations or varying yield.
While investing in bonds is a safer option by comparison, it is always advisable as with any investment, that consumers should carry out sufficient research and seek the advice of a professional prior to investing in bonds.
References:
- Investing in Bonds, Top Things to Know – CNN Money
- Bond Basics – Securities Industry and Financial Markets Association