Re-examining Bonds in Today’s Low Interest Rate Environment
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Experts time and again advise investors to keep a well-balanced and diversified portfolio. This includes a combination of stocks, bonds, real estate, cash and cash equivalents, etc. A mix of investment instruments reduces the overall risk from your portfolio. This happens because while bonds, even with their low interest rate offer guaranteed returns over volatile stocks. However, during dropping rates of interest, investors can question the place of bonds on their investment dashboards. If financial anxiety grows across sectors and investors decide to pull out their money from the market, it is important to re-examine the relevance of bonds.
Here are some aspects to know about bonds that remain relevant in a low interest rate environment.
1. Bonds offer more safety
Bonds are considered to be a lot safer. Bonds typically perform better when there is a downturn in the stock market. This can help you to offset the losses from other investments on your portfolio. When you invest in a bond, the issuer of the bond is obliged to pay you interest, also known as yield or a coupon. This works like a payback for you as you lend money to the bond issuer when you invest. Hence, you get certified returns even when the market is extremely volatile and struggling. Bonds also provide you with higher liquidity than many other types of investments.
2. Bonds can give you a reliable income
Bonds are some of the most bankable streams of investment as they can provide a dependable return. They are less volatile than equities and can offer a continuous flow of income. In fact, since bonds offer better yields than money market funds and certificate of deposits, many investors use their returns from bonds as a source of primary income to meet their daily needs. Even in a low interest rate environment, you still have options such as a high-yield bond or an emerging market debt to ride out market volatility.
3. Bonds are suitable for people in urgent need of money
Bonds are fixed income investments which is why they make for a good option if you are retiring in the near future. Investing in stocks at such short notice can be extremely risky. The right time for riskier investments is usually when a person does not have any major impending expenses like buying a house, sending a child to college, or retirement. Experts too suggest investors nearing retirement to stick to safer bets. This is where bonds can step in. A portfolio with a considerable allocation to bonds is likely to offer less risk and more cushion. If you are thinking of retiring in the next five years or have a child ready to attend college in a few years, you will require a large pool of funds and bonds are a good choice for such goals.
4. Bonds provide capital preservation and appreciation
When you invest in a stock, the principal amount is not necessarily returned to you. However, in the case of bonds, the principal investment is returned to you at the time of maturity. So, even if you yield low returns, your capital is still preserved. Bonds also offer capital appreciation, along with preservation. If you sell off your investment before maturity on the secondary market when the prices of bonds rise, you can earn considerable profits too. This method can be used if you are in need of urgent funds before the bond matures.
5. Bonds work well in economic slowdowns
Economic slowdowns are never a good thing, but bonds can present some hope at such times. When the economy grows at a small pace, the rate of inflation is also low. This upholds the value from the income of bonds and makes it sufficient to meet your goals. Moreover, since a slowdown hampers a company’s stock market returns and overall profits, their bonds come out as better alternatives and offer a greater appeal to investors.
Things to know about investing in bonds
There are some important things to keep in mind while investing in bonds, such as:
1. Short-term vs. long-term bonds
Long-term bonds can present more risk as compared to short-term bonds. Although long-term bonds have a higher rate of interest, they are difficult to predict as they are exposed to many factors over a large timeline. Short-term bonds, on the other hand, are easier to place bets on. There are many resources and data on the web that can help investors to understand how the interest rates are likely to perform one or two years from the time of investment.
2. Government vs. corporate vs. municipal bonds
Government bonds are issued by the government or a public organization. When you invest in a government bond, you lend your money to the government that can be used for various projects. In exchange for your money, the government promises to give you regular yields or coupons at a fixed rate of interest. Corporate bonds are issued by private companies. Just like the government, private organizations also need money from time to time to cover the costs of their operations and overall growth. So, when you invest money in corporate bonds, you lend them the capital in return for which they pay you coupons. Lastly, municipal bonds are issued by municipal localities. These are of two types, general obligation and revenue.
Municipal bonds and government bonds are known to have lower risks as compared to corporate bonds. The tax burden is also considerably higher for corporate bonds, making them a less preferred option for investors who are averse to any kind of risk. However, the returns can be higher in corporate bonds as compared to the other two. A financial advisor can help you pick out one based on your current needs and future aspirations.
3. Bond ETFs
Bond ETFs (exchange-traded funds) are a good option if you have little information on bond trading. You can purchase bond ETFs like any other stock. They offer low risk along with significantly high returns as compared to the money market. You can choose between aggregate bond ETFs and government bond ETFs.
To sum it up
Bonds are a good bet for investors who like to keep their risk appetite as low as possible. They can offer you a steady income and are a lot less volatile than many other investment instruments. Regardless of their low interest rates, they are still considered secure and are highly recommended for a diversified portfolio. Although the percentage of their allocation can be chosen depending on your age, goals, and timeline.
For more information on investing in bonds and making the most of investment opportunities, you can get in touch with financial advisors.