In the investment circle, bond investing plays a big role as a recognized ‘debt security’. It means that, the ‘bond’ is an instrument which can be brought or sold between two parties based on defined parameters such as the amount barrowed, the interest rate and the maturity date. Entities such as the government, businesses as well as private owners can issue bonds while most of the bonds apart from government bonds are subjected to international ranking which allows the investors to pre-determine the level of risk that they are taking.
The advantages of bond investing:
Thus, one advantage of investing in bonds is the ability provided by the ranking systems to recognize the risk involved for the bond investors. Presently there are several agencies issuing ratings on bond issuers and these rating can vary from ‘AAA’, which is considered the most reliable, to ‘C’ or ‘D’ which indicates ‘junk bonds’ or ‘default bonds’ respectively. As mentioned before, the ‘treasury bonds’ issued with the backing of the US government do not carry a rating although they are considered one of the safest bond investment options available. But in certain instances, the return it gains may be less than that of some of the other bonds with a possibility of a higher risk. In any event, managers of ‘bond mutual funds’ usually guarantee its investors that they will only buy bonds which are rated ‘AA’ or above by certain agencies.
Another advantage provided by bonds for its investors is the possibility of a steady income which is more reliable and guaranteed than investments in the stock exchange. It is the advantage of bonds being a ‘debt security’ that brings a reliable income than most of the other investment strategies. Furthermore, in comparison to stocks, although the interest rates can fluctuate, the volatility of its fluctuation could be relatively small in relation to bonds, which lessen the risk of loss to a significant extent.
At the same time, bonds pay a higher interest rate than savings accounts. This would mean that large scale investors could reap higher profits through investing in bonds than placing their money in a savings deposit. Furthermore, being sold at ‘small dollar amounts’ such as in $25 and $50 values mean small scale investors could also invest in bonds based on their principle.
For fund managers, the bond investments require less attention than other types of investments as its maturity path and repayment plan has already being explicitly defined.
Lastly, in relation to taxes on the interest gained, some of the bonds such as the ‘municipal bonds’ could be exempted from Federal taxes and from some of the local taxes. This can make a huge different in the ultimate gain and could make bond investing far more profitable than some of the other investments.
The disadvantages of bond investments:
However, bond investments are not without their disadvantages as well. When considering the recent economic meltdown where mortgage bond defaults almost collapsed the US economy, the reliability of ratings was largely questioned. The reason being that, the ‘mortgage bonds’ which became default were earlier considered highly secure bonds and was rated very high. However, in an instant, these ratings were proved false and bonds became highly unreliable to its investors.
At the same time, when inflation rises, bond values can fall. Thus, not having a hedge over inflation is considered a disadvantage in bonds as against certain other types of investments.
When compared to stock investments, bonds bring little long term return. At the same time, the possibility of interest rate fluctuations after issuing the bonds means that bond values could be subjected to marked volatility in some instances.
As mentioned before, investment on certain bonds could make interest gains tax exempted although most bond gains are subjected to taxes and may eat up into the gains significantly.
Apart from these disadvantages of bond investment, the expected gains out of bond investments could be rather low when selling before maturity and according to some experts the variation could range to almost 20 percent.