In our bonds series, until now, we have discussed what bonds are, how they work, different types of bonds, important terms to know about, and risks in bond investing.
But the critical question is, should you invest in bonds? What are the benefits of investing in bonds? Should you add this asset class to your portfolio? Let’s discuss.
Estimated read time: 3 minutes and 22 seconds
Buckle up. Here we go!
Before we dive in, let’s have a quick recap of what bonds are.
What are bonds?
Bonds are financial instruments issued by governments or companies to raise capital. When you invest in a bond, you are essentially lending money to them in exchange for regular interest payments (coupon). And they promise to return your principal back when the bond matures.
You can read more about the basics of bonds here.
Benefits of investing in bonds
1. Steady income stream
One of the most attractive features of bonds is the steady income stream they offer. Unlike the volatile stock market, where share prices can swing wildly, bonds provide a predictable and stable income in the form of regular interest payments.
For those seeking a reliable source of income to meet expenses or supplement their existing income, bonds can be a dependable option.
2. Diversification benefits
It is necessary to spread your investments across different asset classes to reduce overall risk. Bonds play a crucial role in diversifying your portfolio, especially if you already have equity investments.
Bonds have a low correlation with equity, meaning they often move independently of each other. So, when the stock market collapses, bonds can act as a cushion, helping you minimize losses.
3. Wealth preservation
While stocks can offer the potential for significant capital appreciation, they also come with higher risks. Bonds, on the other hand, are considered safer investments.
When you invest in a bond issued by a stable government or a highly-rated company, the likelihood of default is relatively low. Thus, bonds can be a valuable tool for preserving your wealth and ensuring a more secure financial future.
4. Ideal for retirement planning
As we move closer to retirement, our risk tolerance tends to decrease. Retirement planning calls for a more conservative investment approach.
Bonds can be an excellent fit for retirees or those nearing retirement because they offer a more predictable income flow and a safer harbour for your hard-earned money.
5. Goal-based investments
The timing of our investments and withdrawal is crucial in goal-based investment planning. As we move closer to our goal, our investments should be more conservative.
And bonds can be an ideal investment option for goal-based investment planning, especially for short to medium-term financial goals. Bonds come with various maturities, ranging from short-term to long-term. This allows us to align the bond’s maturity with our specific financial goal’s timeline.
6. Inflation hedge
Inflation decreasing our purchasing power over time is a concern for all of us. While inflation can erode the value of money, bonds can act as a potential hedge against inflation.
Some bonds, like Inflation Indexed National Saving Securities – Cumulative (IINSS-C), are designed to adjust their value with inflation, ensuring that your investment retains its purchasing power.
Should you add bonds to your portfolio?
Now that we’ve explored the benefits of investing in bonds, the question remains – should you add them to your portfolio? The answer lies in understanding your individual financial goals, risk tolerance, and investment time horizon.
1. Risk tolerance
If you cannot handle the wild swings of the stock market and value stability and predictability. Bonds can be an excellent addition to your portfolio.
While they may not offer the same potential for high returns as stocks, they can help you sleep better at night, knowing that a portion of your investments are protected from extreme market volatility.
2. Investment time horizon
Your investment time horizon refers to the length of time you plan to hold on to your investments before needing the funds.
If you have a shorter time horizon, such as saving for a down payment on a house in the next two years, bonds can be a sensible choice. They provide regular income and are less susceptible to short-term market fluctuations, ensuring your money is readily available when you need it.
Diversification helps you avoid putting all your eggs in one basket and improves the potential for stable, long-term returns.
If your portfolio is heavily weighted towards stocks, adding bonds can help diversify your investments. As mentioned earlier, bonds often move differently than stocks, which means they can balance out the overall risk in your portfolio.
Also, bonds can be a valuable addition to your financial toolkit, providing a steady income stream, wealth preservation, and acting as an inflation hedge.
However, remember that no investment comes without risk. We have discussed the types of risk in bonds here.
Remember to share these insights with your buddies. Until next time!
If you are like us, who likes to analyse a little more or check out content in different formats, well you are in luck. Below you can find some suitable content we found.
Note: We don’t have any affiliation with them. We are sharing links only for educational purposes. The opinions expressed by them belong solely to them and do not reflect the views of Vrid.