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Advantages and Disadvantages of Investing in Bonds

Advantages and Disadvantages of Investing in Bonds

Planning to invest in bonds? The following article, which brings forth the advantages and disadvantages of investing in bonds, will help you in making up your mind. Read on...
Aastha Dogra
If you have extra money at your disposal for investment, you should make sure that you do not put all your eggs in the same basket i.e. invest in only one type of investment instrument. In the uncertain economic circumstances that are prevailing today, making diversified investments is the need of the hour, so that, even if you experience losses in one investment, the gains in other ones can make up for it.

Stocks, gold, real estate, mutual funds, fixed deposits in banks, and bonds, these are some of the most popular forms of investment today. Some of these investments can be highly risky, such as stocks, while bonds, on the other hand, promise safety and a fixed, regular income. Though, let me tell you that none of these investments are without their own fair share of pros and cons. Now, let us see what are bonds.

What are Bonds?

Bonds can be defined as debts, which a company or the government undertakes, by borrowing money from the public, when it is in need of funds. There are different types of bonds issued to the public today, such as U.S. Government bonds, municipal bonds, corporate bonds, and mortgage-backed bonds, to name a few. The funds that are raised through corporate bonds might be needed to invest in further growth of the company or to invest in new ventures. When the government issues bonds and raises money, it is usually used to finance various public works such as building roads, maintaining street lighting, keeping up the government buildings and parks, etc. In exchange for these borrowings, the company/government pays the investors a fixed rate of interest, which is paid at a stipulated time, for a fixed period. This makes bonds a reliable source of investment. You may further go through how do bonds work. Next, we move on to know, the advantages and disadvantages.

The biggest advantage of investing in bonds is that there are very less chances that you will lose out on your investment. So, people who do not believe in taking undue risks with their money, should invest in bonds. People who are nearing retirement and thus, cannot afford to risk their hard-earned money, will find dependable bond investments very suitable.

When compared to other safer forms of investments, such as saving accounts in banks, bonds pay a much higher rate of interest. So, instead of keeping money in a bank, people can invest in bonds and earn a good interest rate. Secondly, with bonds, there is no anticipation and anxiety over when the principal amount will be paid or when the interest will be received as everything is pre-decided and the investor is aware of the maturity date and the time when interest is due on his investment. Thus, bonds do not need constant monitoring like some other investment instruments. Lastly, certain bonds, such as municipal bonds, can sometimes be exempt from income tax. This adds on to the profits earned through them.

The foremost disadvantage of bonds is that when compared to shares, gold and real estate, the rate of interest that they generate is very less. That's why, people who want to double/triple their money with some good investments, do not put their money in bonds.

Another disadvantage of bonds is that there is always a risk of the company which has issued the bonds, going bankrupt. Considering the effect that the economic recession has had on various businesses in recent years, this is one possibility that cannot be completely ruled out. So, in case this happens, the bonds will not yield any interest, plus the investor will lose out on the principal amount too. Then there is one issue related to long term bonds. The duration of the long term bonds can be anywhere more than twelve years. If an investor's money is tied up in some low yielding long term bonds and suddenly the interest rates of banks or other bonds go up, there is nothing much the investor can do about the situation. In such a case, an investor will end up making much lesser money as he could have, if he had invested in other instruments.

It can be said that bonds, if purchased during one's middle age or near retirement, can turn out to be a good investment as they generate a regular income. However, people, particularly youngsters, who have the capacity to take risks and are looking for high yielding investments, should definitely look elsewhere.