A bond is a sort of financial product that enables an investor to lend money to a government, municipality, or company in exchange for consistent interest payments and the return of the principle at the bond’s maturity date. An issuer, such as a government or business, might sell bonds to investors in order to raise money when it needs to borrow money. Until the bond matures, the issuer agrees to pay bondholders a predetermined rate of interest, typically every six months.
When you purchase a bond, you join the issuer’s list of creditors. In exchange for the bond, you lend the issuer some cash, and the company agrees to pay you interest at a set rate until the bond’s maturity date. The bond’s issuer will reimburse the bondholder for the bond’s principal when it matures.
For those searching for a more cautious investment strategy and/or a reliable source of income, bonds can be a tempting option.
Here are several important roles bonds play in your investment portfolio
Diversification: Bonds can aid in the diversification of a stock-heavy portfolio. They reduce a portfolio’s overall volatility because they typically have a low or negative correlation with stocks.
Income: Through the interest payments they provide, bonds can offer a consistent flow of income. Investors who are getting close to retirement or who are searching for a steady stream of income may find this to be especially helpful.
Preservation of Capital: In general, bonds are thought to be less risky than stocks, and they can help in capital preservation during periods of market turbulence.
Risk Management: When equities decline, bond prices often rise and vice versa. This enables bond investments to serve as a buffer against stock market volatility, assisting in lowering a portfolio’s total risk.
Similar to other forms of investments, while bonds may sound like a good idea, it is important to understand some aspects of them before you start investing in bonds.
When you invest in bonds, there is a chance of the bond issuer falling behind on interest payments or not paying back the principal when the bond expires. This is known as credit risk or default risk. Investors are advised to consider the creditworthiness of the issuer before they start investing.
Investors should also consider the length of time it takes for the bond to expire. Longer-term bonds are considered riskier compared to short-term bonds as they are more sensitive to changes in interest rates.
It’s crucial to remember that bonds include risk, and their value may change depending on interest rates and the issuer’s financial situation. Before investing in bonds, it’s critical to diversify your portfolio of bonds and comprehend the dangers associated. You can choose the appropriate bonds for your investment portfolio with the aid of a financial counsellor or a bond expert.