No matter what type of investor you are, bonds are almost always a good choice. But new regulation and market movements may make it an even better time to invest in bonds. Read on to find out if bonds are the right investment choice for you.
What is a Bond?
When purchasing a bond, investors are essentially lending money to the financing organization for a set period of time with a variable or fixed interest rate. There are a variety of bond options available, but most come from companies or governments needing to raise money.
Bonds are stable investments that don’t carry much risk because the lending organizations are required by law to repay the bond barring extreme situations. Many novice investors start with bonds, but they can be a great investment at any stage to balance out riskier investments from other market areas.
Bonds vs. Bond Funds
A bond funds is basically investing in a mutual fund of bonds selected by a financing group. Bond funds are a great way to diversify without spending a lot of money on individual bonds you select yourself, especially for corporate or international bonds that often have high minimum purchase requirements for individual investors. Unlike individual bonds, bond funds don’t have a maturity date, which means the value changes with the market and the interest rate. This means that your profits aren’t as predictable, but some experts say the risk doesn’t change the profit much over time.
Are There Risks?
No investment is risk-free, and although some risks are mitigated through bonds, that doesn’t mean they are a sure bet. In general, the more risk, the more reward — if you’re willing to invest in a high-risk bond, you can profit from a large reward. The biggest risk factor is who is issuing the bond. Issuers who aren’t as credit-worthy often offer higher yields as a way to entice investors. These high-yield offers are often referred to as “junk bonds” and may come from a relatively unknown company looking to raise some cash. Bonds with the least amount of risk are known as Treasury and come from the U.S. government. These bonds are about as risk-free as can be because they are back by the government that has never defaulted, but they also pay a much lower yield than loans from other sources.
What to Consider When Investing in Bonds?
Not all bonds are created equal, and investors have quite a variety of choices. Aside from considering how risky you want your investment, the two other biggest factors are interest rate and time.
The general rule for interest rates is that as they rise, bond prices decrease. New bonds are issued at the current high interest rate, which means existing bonds with lower interest rates are less valuable. The changing interest rate is mostly a factor if you try to sell your bond on a secondary market before it reaches maturity. If your bond is lower than the current interest rate, you may end up losing money on it. However, if you keep your bond until it matures, you are essentially guaranteed a payout of at least the amount you paid for the bond.
Rewards can also come with the length of the bond. Issuers tend to pay higher yields for longer-term bonds because the investors’ money is being loaned for a longer period of time. If you want to risk locking money away for 10 years, you can almost always score a higher yield on a 10-year bond than a one-year bond.
Why is Now a Good Time to Invest?
Because interest rates have such a large impact on bonds, the uncertainty about Federal Reserve rate hikes makes now a great time to invest in bonds. Most traders predict the Fed will raise the interest rate a few times over the course of 2016, which would decrease bond prices and increase yields — a perfect combination for potential bond investors. Rising interest rates also lead to an unpredictable market, which can make even more enticing to go the more stable bond route.
There’s never a sure thing in the market, and some traders will say that the bond boom is on the way out. However, with so many options and fairly consistent results in a volatile market, bonds are definitely worth a look for most investors.