The Best Bonds are Low Risk

There are numerous investment options that are available to an investor such as stocks, bonds, precious metals and stones etc. Bonds are a good investing option for those who want to invest in a low-risk instrument. They are basically instruments of debt security. When someone purchases a bond, he basically lends money to the entity issuing the bond for a specified period of time. In return for this, the entity pledges to pay interest to the lender on a pre-decided rate of interest till the time specified after which the borrowed money (principal) is returned to the investor. The biggest advantage is that bonds provide capital protection i.e. the money that is invested will be returned in full.

There are different types of bonds which are basically categorized by the type of entity that has issued them. Some of the best bonds available in the US are:

• US Government bonds – as the name suggests, these are issued by the US government. These are considered to be extremely safe as the government can print more money to repay them. Thus the risk of default in these is very low. They are usually AAA rated and the interest given is tax-exempted thus making it a very attractive option. Since this type of bond provides so many benefits, the rate of interest that it gives is pretty low as compared to the other bonds.

• Municipal bonds – again as the name signifies, these are issued by the state and municipal governments. These are also very safe although not as safe as the governments bonds as the states can’t print money. They are also tax-exempt just like the other bonds. The rate of interest provided in these is a little higher than the government bonds as they carry a little more risk. The municipal bonds with AA and above ratings are pretty safe so are a very good option to get into.

• Corporate bonds: are issued by various companies in order to raise capital. They usually are considered to be risky as they are not backed by government and as has been seen occasionally, many companies get liquidated. Since the risks on these bonds are high, they provide higher rates of returns as compared to the other types of bonds. So if one is willing to take the risk, corporate bonds are good sources of income although one should take care to invest in bonds which are rated AA or higher.

Bonds remain a necessary part of any portfolio of a well diversified investor. Although bonds in general are considered to be low-risk/low-return, we have seen that even these have various levels of risks and returns. Thus any investor should always consider the fact that higher returns mean higher risk and therefore should go for a bond that suits their risk appetite.

3 thoughts on “The Best Bonds are Low Risk

  1. One thing that you didn’t mention with respect to bonds is the duration to maturity. Longer term bonds are more risky than shorter term ones, because with longer term bonds, the interest rate paid on the bond is locked in for a longer period of time.

    For instance, let’s say you have you get 4% on a 1 year bond and 4% on a 30 year bond. If interest rates rise to 10%, the 1 year bond matures and you can reinvest your money in a 10% bond. However, with the 30 year bond if you want to reinvest, you either have to sell your 30 year bond at a loss and reinvest or just hold onto it and keep earning 4%.

    The risk you describe is the risk of default which is only one piece of the overal risk of the bond.

  2. And let’s not forget the risk of inflation, which is extremely high for long term bonds.

    That’s because over the course of 20 or 30 years, money loses a lot of value even if inflation remains at the relatively low rates it has been (officially) recently — 2%.

    At a rate of 2% inflation, a dollar loses half its purchasing power in 36 years.

    Therefore, the purchasing power of the interest income from 20 years bonds will by a little over half.

    If your current bond income is just enough to get by on, you’ll eventually see your standard of living fall.

    Therefore, if you live on bond interest, you must reinvest at least 2% of your net after-tax interest, just to stay even.

    And that’s only if inflation remains so low. If it goes higher (as many expect it will), you’ll be in trouble.

    And by some measures, inflation is already much higher than official figures. The government doesn’t count price rises in food and fuel. So if you need bond interest to pay for groceries and gasoline, you can’t count on the government’s official inflation figures. You better make sure you have enough to pay for your family’s expenses.

  3. Thanks for a really interesting read, learn quite a few tips here, trying hard to improve my credit , i did a consumer proposal 7 years ago and just now i am starting to rebuild my credit slowly but surely and trying to avoid that credit card trap.

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