Advantages and Disadvantages of Investing Bond Investment are usually comes with risk and there have their own pros and cons themselves. Bond is normally known to be safer and low risk compared to invest in shares. Yet, there are some advantages and disadvantages that have to be take note as follow before investing: a) Advantages of Investing Bond i. Predictable Advantages Bonds are predictable. You know how much interest you can expect to receive, how often you’ll receive it, and when your principal (the bond’s face value) will be repaid (maturity date).
ii. Income Advantage
An advantage of bonds is that they tend to be a more secure place to invest money than stocks. Bonds are debt securities. When you buy a bond you are lending money to someone who promises to pay you back with a set amount of interest by a specified date. Bonds can be issued by a government entity, a business or a private issuer.
Bonds can be traded like other securities, so their purchase price can change. However, the fluctuation of the price tends to be less volatile than stocks. b) Disadvantages of Investing Bond i. Rating Advantage Bonds are subject to ratings systems.
This allows investors to gauge how reliable a bond is expected to be. There are several companies that assign letter grades to bonds based on their credit worthiness. AAA is the highest rating. A bond rated AAA is considered very likely to be repaid on time and in full. There are also ratings of AA, A, BBB, BB, B, CCC, CC, C and D. Bonds rated with Cs are considered unreliable and referred to as “junk bonds. ” A bond rated D is in default. Treasury bonds backed by the United States government have no ratings. They are considered the safest bonds of all.
Many bond mutual funds guarantee investors that they will only buy AA bonds or better. ii. Security Disadvantage Bonds are only as good as the borrower’s ability to pay the loans back. If the issuers of the bonds cannot pay back what they agreed to, the bonds will default. It is also a disadvantage if bonds are repaid early in a bond mutual fund. The bond fund managers who were expecting continued income from those bonds may suddenly be forced to buy other bonds that don’t pay as well.
Longer maturity bonds can fall in value with fluctuating interest rates. This lowers the sale price of the bonds when it comes time to sell them. ii. Risk Disadvantage We cannot always trust the ratings systems. The most prominent example of this is the home mortgage crisis of 2008. For years preceding the crisis, bonds and bond mutual funds containing mortgage loan debt were highly rated and considered safe. At the time, they provided consistently good returns and rarely lost money. When it became evident that there would be wide scale mortgage defaults, agencies like the Federal National Mortgage Association, known as Fannie Mae, and the Federal Home Loan Mortgage Corporation, known as Freddie Mac, were on the verge of collapse.
In September 2008, the Federal Housing Finance Agency seized control of Fannie Mae and Freddie Mac to prevent the entire economy from collapsing under the weight of so much unpaid debt. The bonds containing the unpaid debt became virtually worthless. iv. Long Term Disadvantages Long-term bonds will have our money tied up in low yielding bonds should interest rates go up. Unlike stocks, bonds don’t offer the possibility of high long-term returns. Younger investors and those with several years to go until retirement would be better served by limiting their bond purchases and opting for equity buys instead.
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