Governments, Companies, and government agencies issue bonds to raise money for projects. When bond matures, issuer pays you back in full. And it pays regular interest payments until bond reaches maturity. These investments have advantages and disadvantages. Hence, you are able to address these factors in such way that they maximize profit. See advantages and disadvantages of bonds and common stocks.
Bonds often are backed. This means that issuer has way of guarantee. It will pay you what it owes. For instance, U.S. Treasury backs government savings bonds. Fact bonds are backed into low risk compared to other forms of investment. On other hand, bonds are not completely risk-free. If issuer goes bankrupt, it may default on its bonds.
However, in bankruptcy bondholders are paid back first before shareholders. An advantage of bonds is that various companies provide ratings for companies that issue them. The best rating is AAA. These ratings are not guarantee of what will happen in future. But they offer guide for assessing bond risk and whether you will get your money back.
Because bonds are safe investment, they provide low return. Bonds do not produce returns that keep pace with other investments. Such as stocks. Bonds also have trouble keeping up with inflation. However, bonds are fairly predictable. You must know what interest rate company is paying. Subsequently, it is easy to plan financially with bonds based on returns you expect.
Bonds tie up your money for an extended period of time. Bonds can be considered short-term investments, but depending on bond. And tie-up period may be as long as 30 years. Usually, you can cash in bond before it matures but not without penalty that reduces overall value of bond. This makes it difficult to shift your money from place to place. Hence, keep it with you based on your needs.
Some bonds are exempt from certain taxes. For example, interest on U.S. savings bonds is exempt from state income tax. This increases value of bonds. However, you sometimes have to meet certain conditions to qualify for tax advantages. For instance, you can’t exempt your interest from federal income tax unless your income is below certain level. According to Retirement Planning Services.
The majority of bonds are registered securities. This means issuer has record of person or agency that purchased bonds. If your bonds are lost or stolen, registration is useful in tracking bond. At same time, registration means you may not be able to simply sign over bond, which makes transferring ownership more complicated. With U.S. savings bonds, for example, you must change registration with Treasury and have bond reissued to show change in ownership.
Financial experts advise putting your funds in many different investments to minimize risk. This way, if one investment fails, you don’t lose everything. By purchasing some bonds, you spread your money out over more types of investments and therefore have a stronger portfolio overall. The stable rate of return from bonds in your portfolio also can cushion volatility in the stock market.
Disadvantages of Bonds
Bonds are also focus to various other risks such as call and prepayment risk, credit risk, reinvestment risk, liquidity risk. Additionally, like exchange rate risk, volatility risk, inflation risk and yield curve risk. Price changes in bond will immediately affect mutual funds that hold these bonds.
If bonds value falls, then portfolio value also falls. This can be damage for professional investors. Such as bank, insurance, pension funds and asset managers. If there is any chance to sell bonds and cash out so interest rate risk become real problem. Check how to calculate tax payable on your capital gains
Bond prices can become volatile depend on credit rating of issuer. Credit rating agencies like Standard and Poor’s and Moody’s. There is no guarantee of how much money will remain to repay bondholders. Some bonds are callable. This means that company has agreed to make payments plus interest toward debt for certain period of time. Therefore company can choose to pay off bond early. This creates reinvestment risk, means investor is forced to find new place for his money.
Finally, see differences between Callable bonds & Non callable bonds. And also see difference between investing in bonds vs. savings accounts. Probably, check what risk of investing in bonds is. You need to understand risks and benefits of bonds.