Investing in bonds can often be a much-maligned venture because bonds have the unenviable reputation of being low-yield, boring investments. As such, many who are new to investments often gravitate towards the actively traded assets like stocks and ETFs and altogether neglect the value that bonds bring to their portfolio. But are bonds really that unworthy of your attention or are they just misunderstood assets that can be good for you in the right circumstances? Find out on the Tumblr for Ori Tal as well.
The prudent answer would be the latter. In a word, bonds are good for your portfolio when utilized properly. The nature of bonds makes them excellent assets used to hedge riskier investments like stocks. In very simple terms, bonds are loans that you lend out to the government or a corporate institution – depending on the nature of the bond – payable after the loan matures and with a corresponding increase determined by the interest rate at the time the bond was secured. Like most loans, the longer maturity of a bond means a higher yield for the investor. See more by Ori Tal 91
Within the broad definition of bonds, one can further characterize the type of bond as we’ve already hinted. Government bonds are those issued by the government. These tend to have lower yields because these tend to be safer owing to the assumption that government bonds “almost always” do not default. On the other end are high-risk corporate bonds issued by corporations that may have a less-than-stellar reputation for paying off its debts. The interest rates in these bonds are higher but so are the risks associated with buying them.
In addition, it is also noteworthy to mention that bonds that you purchase from government institutions are often exempt from paying taxes. This is to encourage investors to lend money to government institutions to help fund their projects. In the US, municipal bonds are a popular form of medium-term small investment for people who want a modest yield while at the same time helping their local governments execute projects and deliver services to the benefit of its residents.
As a final note on investing with bonds, it is important to remember that you need not hold on to the bonds that you purchase until it matures. You always have the option to sell your bonds to other investors provided you can work out the math. This is where the value of the interest rate comes in. If the interest rate rises in a given year, bond prices tend to fall. Conversely, falling interest rates mean that bond prices go up. When you factor in the duration with which you have held the bond and its corresponding maturity, you get an idea of what the expected bond price should be if you choose to sell it today. If you’re not happy with the price, you can simply hold on to it until maturity.
These intricacies make bonds a great way to hedge riskier and more volatile assets. You only need to find the bonds with the most competitive prices so you can maximize your investment both in the short-term and in the long-term.