Bonds are the classic “conservative” investment – low or no risk, but only modest returns.
When you buy a bond, in effect you are lending money to a company or a government, which that company or government is then obligated to pay back to you, with interest, after a set period of time. (You can also buy and sell bonds though. So it’s not like if you buy a twenty year bond, you can never get any money for it until twenty years have passed. You could sell someone else the bond before then, basically selling them the right that you now hold to collect that money after twenty years.)
Let’s look at some of the pros and cons of investing in government bonds specifically:
*PROS*
* Predictable interest rate.
Bonds don’t have the volatility of, say, stocks. You are paid a certain predetermined interest rate over the life of the bond.
* Lack of commissions and trading fees.
Often bonds can be purchased directly from the issuing authority. In the case of government bonds, you can buy bonds directly from the federal, state, or local government.
* Tax advantages.
The profit on government bonds, especially municipal bonds, is often tax free.
* Safety.
The main benefit most investors value about government bonds is their safety. Unless the government goes under entirely (in which case you’ll have a lot more to worry about than whether your investment paid X percent or Y percent), you’re not going to lose your money. Note though that local government bonds, while still very, very low risk, are not as safe as bonds issued by the federal government. On rare occasions municipal governments have defaulted on bonds, or at least failed to make the interest payments in full.
* Patriotism.
Some people believe you are supporting your country by loaning money to the government, though this certainly is not a universal sentiment. Historically, attitudes can change about such things, as attitudes about government change. During World War II, there was a big push to “buy bonds” as a sign of patriotism to support the war effort. A few decades later, a vice presidential candidate was laughed at for suggesting that one has a patriotic duty to pay one’s taxes.
*CONS*
* Lower profit.
The flip side of not having to worry so much about volatility or default is that the rate of return on bonds is quite modest. Over the long run, just buying a wide variety of stocks invariably does better, albeit with a great deal more fluctuation along the way.
The risk of default can be considered a con of bonds, as if the issuing entity goes under, it takes your money with it, but as noted above, this is far less of a risk with government bonds than with certain other bonds, like those issued by a company that may be shakier financially than it looks from the outside.