Jan 22 Benefit And Drawbacks Of Investing In Bonds
Bonds are debt instruments that are issued by banks and business corporations to borrow money at an interest from the public. Also called fixed-income securities, bonds have a guaranteed maturity date and a fixed ROI upon maturity. Due to their financial guarantees, bonds are considered as the safest investment instruments in the financial world. Discussing whether you should invest in bonds with your advisor or accountant that provides New Jersey accounting services for you is a good idea.
4 Main Types of Bonds
Government bonds are the oldest and most popular fixed-income instruments in the world. As the name implies, government bonds are issued by the government to source funds for specific development projects, like the construction of dam, highway, railway etc. They are usually issued at a discounted price and they have a very high credit rating. Again, as the name suggests, municipal bonds are issued by municipal or local governing entities.
Like the government bonds discussed above, municipal bonds or “munis” are used to borrow money for specific development purposes like building of a school, hospital, social hall etc. Government and municipal bonds are exempted from income taxes.
Corporate bonds are issued by companies to source funds for corporate expansion. They can either be secured, attached to corporate assets and hence payable if the company is liquidated, or unsecured, unattached to anything and hence may not be repayable after liquidation.
The last types of bonds are called floating rate bonds. Unlike all the other types of bonds, floating rate bonds do not have a fixed rate of interest and hence have the lowest credit rating and least market value. As investment instruments, bonds have the following advantages and disadvantages.
Benefits
As mentioned above, bonds particularly government and municipal, are considered the most secure investment instruments. Bonds are less volatile than stocks and their value is not affected by day-to-day market fluctuations. Bonds also offer higher interest rates than many other safe investment options like money market funds, certificates of deposit, and savings accounts. Bonds are also easy to liquidate because their higher interest rates and guaranteed maturity makes them a very attractive investment option. Another benefit of investing in bonds is that they usually feature legal protection for the investor. Bonds usually come with indentures and covenants, which are formal agreements and clauses to protect the investor. Another advantage of bonds is that they are of many different types to suit any type of investor. And last but not least, bonds require very little management on the side of the investor.
Drawbacks
One of the main disadvantages if investing in bonds is that they offer the lowest interest rates as compared to other forms of asset classes like real estate, stocks, gold etc. The only positive tradeoff here is that bonds are the safest among all these high interest investment options. As such, they offer lower but guaranteed ROI. Another major drawback of investing in bonds is that the investor can lose their money if the company goes bankrupt. This con usually affects corporate bonds and the most risky bonds in this case are the unsecured ones. Secured corporate bonds can be repaid following the liquidation of the company’s assets. Unsecured bonds might not be repaid at all if the firm goes under. And lastly, long-term bonds can tie up a huge amount of your money for very low returns. Long-term bonds of 10 years or more can stagnate your investment and cause you to loose out on new more rewarding investment opportunities. Your accountant or financial advisor can help you determine if bonds, and specifically which type or types, are an investing avenue you should pursue.
