Bond investments yield a regular coupon payment and return the face value of the bond upon maturity. However if you are after steady income it might be advisable to stick with short to medium term bonds. While investing in bonds seem as one of the safest investments on the market, they are not entirely free from risk.
Long Term Investment Bonds – Risks
Mentioned below are some of the risks associated with investing in bonds:
- Interest Rate Risk: One of the major risks associated with investing in bonds is the interest rate risk. Simply put, this denotes that short term bonds are the safest as there is usually minimal interest rate fluctuation over the short term, in comparison to long term, high-yield or junk bonds which are subject to higher interest rate fluctuations. One fact that needs to be taken into consideration is that the longer the term of the bond the higher the return while the greater the interest rate risk and vice versa. Investors should consider the time frame of the bond while investing because at times it may be more prudent to invest your money elsewhere and hedge your returns against inflation.
- Assumed Risk: This risk refers to credit rating risk. Credit ratings allows investors to make more informed decisions while investing in bonds. The major bond ratings agencies are S&P and Moody’s. Bonds with higher ratings carry lower risk and bonds with lower ratings carry higher risk. Bonds which have a rating of triple-B and above are considered investment grade. It is safe to assume that in a bull market junk bonds may be a safe option but in a bear market investment grade and higher bonds are the usual bond investment choice.
- Bonds May Be Called: Certain bond investments may have the option of being called back by the issuer. This is done in order to protect the bond issuer from paying higher interest rates. The bond investments which have call back options entitle the bond holder to receive a predetermined amount on the call date prior to the maturity of the bond. This however constitutes the risk that you may have to reinvest your money at a lower interest rate.
Advantages Of Bond Investing
Listed below are some of the advantages of investing in bonds:
- Bond investments are considered predictable investments. This is because you know how much of interest you will receive, when you will receive it and how much money you will receive upon the maturity of the bond.
- Investing in bonds is considered to be more stable than stocks. This is true more in bear market owing to the stable nature of bonds.
- Retirees and long-term investors consider bond investment the safer option as it assures them of a fixed income stream should they decide to buy and hold the bond.
- The interest rate paid by a short term bond usually exceeds that offered by a bank’s savings account.
- Certain bond investments, e.g. municipal bonds offer tax exempt income.
- In comparison to other forms of investments, a bond investment require less management.
Disadvantages Of Bond Investing
Some of the disadvantages of investing in bonds are:
- Bonds offer no hedge against inflation rates as inflation is one of the main reasons why bond prices fall.
- Bonds offer lower interest rates in comparison to stocks over the long term.
- Bond investment prices may vary depending on market interest rates.
- There is chance that certain corporations or government subsidiaries may go bankrupt thereby leaving your bond investments worthless.
- Long term bond investments usually tie up funds for a long time which can be invested elsewhere for better returns.
These are some of the advantages and disadvantages of investing in bonds and once you have read everything about investing in bonds and learned all the facts, you are likely to be more aware of what it takes before investing in bonds.
References:
- Investing in Bonds Factsheet – Ohio State University
- Buying Bonds: Advantages and Disadvantages – RL Rouse