Pros & Cons of Investing in Bonds
What are Bonds?
A bond is a debt security, by which you are lending money to a government, municipality, corporation, federal agency or other entity known as the issuer. In return for investing in the bond, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it becomes due.
Why Invest in Bonds?
It is always prudent for an investor to maintain a diversified investment portfolio consisting of bonds, stocks and cash in varying percentages, depending upon individual circumstances and objectives. Bonds help you to diversify your portfolio, thereby, reducing your risk exposure.
Investing in bonds provides a predictable stream of income and repayment of principal.
Bonds maturing within three to five years will hold on to the value that they are worth. They offer some protection against stocks related losses in a portfolio.
The negative side of investing in bonds:
All investment products have drawbacks. Bonds are no exception. Some of the negative aspects of investing in bonds are:
Most bonds have a call option. This gives the issuer the right to call back the bonds held by investors generally after five to ten years. When the issuer calls back a bond, it pays your principal back along with the accrued interest and perhaps, a small premium. Issuers adopt this strategy when they can obtain money at interest rates lower than that of the bond in question.
When interest rates go up, the price at which the bond can be sold goes down. If you are forced to sell the bond due to pressing circumstances, you may not back the entire amount invested resulting in losses.
Long-term bonds can tend to be volatile and can somtimes fail to keep up with inflation.
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