Why Invest In Bonds?

Why Invest In Bonds?

Investors choose to invest in bonds for various reasons and each of them has different risk preferences. Investors who purchase government bonds or high quality corporate bonds usually do so because they are considered safe assets. This means that it is highly unlikely that the institution issuing the bond will default on their debt obligations. However, investors who invest in junk bonds generally do so because they are attracted to the higher returns that are accompanied by higher levels of risk.

Low Risk

Low risk bonds are ideal for investors who wish to store their money in safe assets while earning higher returns than those offered by traditional savings accounts. Savings bonds are offered by the government, and are considered to be the safest bonds because it is highly unlikely that the government will default on its debt payments. Because of the low levels of risk, these bonds also earn lower returns.

Bonds that have a short maturity are also considered to be low risk. The reason for this is simple. When you hold onto a bond for a short period of time, it is less likely that the issuer of the bond will default on their debt obligations. Because longer term conditions are more difficult to predict, this uncertainty causes the riskiness of long term bonds to increase. Examples of short term bonds include treasury bills and other money market assets. However, it is important to keep in mind that the term and risk relationship does not necessarily apply to long term government bonds that are held until maturity.

Predictable Income

Bonds are referred to as fixed income assets because their cash flows do not tend to change and are uninfluenced by factors such as the inflation rate. This means that the investor can always predict the amount of income that they will earn from the bond. Since the interest payments are also paid out on a pre-determined schedule, the investor will also be able to determine when they will be paid. Although there are special bonds that have their returns tied to inflation, the majority of the bonds are fixed income assets.

This is an attractive investment for investors who are concerned with earning a higher rate of interest than that offered by traditional savings accounts but do not wish to take on additional risk. Although it is always possible that the issuer of the bond may default on their obligated payments, this is very rarely the case with government bonds and high rated corporate bonds.

Money with a lock around it.

Savings

There are many advantages to investing in savings bonds for retirement or future education expenses. First of all, you will earn more money by investing in bonds than by sticking your funds in a savings account. In addition, there are also tax advantages. When an investor cashes in their savings bond, they are not required to pay interest on the interest income earned. This can make them an attractive alternative to the traditional individual retirement savings accounts. In addition to the tax benefits, there are no penalties associated with redeeming the bond early. For certain retirement savings accounts, the individual must wait until they are nearly sixty years of age before they can withdraw money. However, bonds can usually be cashed in after five years with no penalties imposed on the investor.

One of the biggest criticisms of safe bonds is that they earn a low rate of return. However, this may be an acceptable trade off for an investor who is not willing to invest in risky assets.

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