Ask Your Financial Advisor If Bonds Are the Safest Investment Options for You
There exist multiple avenues for investing your funds. Some commonly known asset classes include bank deposits, stocks, bonds, and mutual funds. Besides these, there are some alternative investment avenues as well. These consist of real estate, hedge funds, private equity funds, and commodities. Given the wide variety of options, it may, at times, get a little overwhelming to make an investment decision. This is why it can be helpful to approach financial advisor to seek some professional guidance.
A financial advisor assesses your current pecuniary situation and evaluates your financial goals. In addition, the advisor also takes into account your risk appetite. Thereafter, using their professional acumen, the advisor recommends the most suitable investment options for your profile. If safety is one of your key investment preferences, bonds are known to be a better bet. However, it is recommended to seek the proficient guidance of your financial advisor before deciding to invest. Besides, it is also crucial to discuss the relevant points that aid in gathering all the requisite details. An elaborative discussion can help you in comprehending the functionalities of the financial instrument better. This, in turn, makes you confident about taking the most suitable investment decision.
Here are the five key questions to ask your financial advisor to know if bonds are a safe investment avenue.
- Are bonds a better bet than stocks?
- How to assess the creditability of a bond?
- Are returns on bonds predictable?
- Is the capital investment safeguarded from erosion?
- Is investing in bonds more profitable than holding cash?
Companies, sovereign governments, municipalities, and states issue bonds. The issuance proceeds are normally utilized for financing their projects or operations. Hence, bonds represent a loan made by the investor to the issuer. As a result, the investor becomes the creditor or the debt holder.
Debt holders enjoy a priority over shareholders. During bankruptcy, the company settles the credit dues before equity. Hence, bondholders are ranked above stockholders. Even in the worst-case scenario, bondholders normally receive some money back, whereas shareholders may lose their entire investment. Therefore, bonds create a safer haven for investments.
You can normally assess the creditability of a bond through its credit rating. The rating indicates the financial health of the issuer. It also hints at the ability to meet interest as well as principal dues in a time-bound manner. The rating is a function of multiple factors. These include the financial standing of the issuers, the outlook of the management, peer competition, as well as other macroeconomics factors.
Bonds with higher ratings are known as investment-grade bonds. They have a lower probability of defaults. On the other hand, bonds with a lower rating are non-investment grade bonds. These are also known as junk bonds. A lower rating depicts a higher probability of the bond issuer defaulting. Further, junk bonds consist of two variants – fallen angels and rising stars. Fallen angels are bonds that were previously investment-grade bonds. Likewise, rising stars are bonds with an improving credit, but may still carry the junk rating. The revision in the rating is due to the changing credit quality of the issuer. The ability to assess the creditworthiness of the bond issuer helps to select the most suitable bond. It also increases your confidence to invest your money in bonds.
Bonds belong to the category of fixed-income securities. They provide returns in the form of periodic interest and repayment of principal at the time of maturity. Hence, returns from such investments are gauged in advance. But, this is not possible in variable income securities. Here the returns depend on underlying factors like short-term interest rates.
To elaborate further, the parties to a bond include the investor who is the lender and the issuer who is the borrower. The issuer pays interest at the coupon rate for allowing the use of funds. The issue price is the issuance price of the bond, and the face value represents the maturity value, i.e. the amount that you receive on maturity. You receive periodic interest on the face value of the bond. Therefore, you can enjoy a steady cash flow during the tenure of the investment. Moreover, bonds are normally rated by credit agencies, so you may refer to the assigned rating to estimate its credit worthiness. Thus, bonds aid in creating a stable investment portfolio.
Bonds represent the investor’s lending to the issuer. Since loans are repayable at predetermined terms over-scheduled periodicity, you can expect a risk-free bond held till maturity to mature at par, which preserves your invested capital. For instance, while approaching retirement, you may invest in bonds to enjoy greater stability. Investment-grade bonds exhibit a lower probability of default and can aid in creating a retirement corpus.
Investing in the stock market that is notorious for its volatility, the performance of stocks is linked to the performance of the market. As the market is highly unpredictable, there could be a possibility of capital erosion. However, bonds normally provide preservation of the capital invested.
Holding cash is not rewarded with any returns. It may also show a decline in the purchasing power on account of inflation. Besides, you incur opportunity costs while depositing cash in your account. Opportunity cost refers to the potential returns that you could have enjoyed by investing the cash in bonds. By deciding to keep your money in cash, you forgo the opportunity of making stable returns at lower risks.
Bonds normally carry interest rates higher than the interest rates of a savings bank account. It is a debt instrument with a potential for predictable and consistent income. Moreover, being a creditor to the issuer gives you a priority status at the time of settlements. So, you usually enjoy better returns when you invest in bonds rather than parking your funds in a bank account.
To sum it up
As fixed-income securities, bonds can be a safer investment option. They are ideal for investors looking for stable returns and low risk. Besides, bonds also aid in diversifying your investment portfolio while combating market volatility. However, they carry a certain level of risk as well. For instance, bonds with a non-investment grade are known to be risker. But, this is typically compensated by a higher coupon rate. Hence, it is important to assess the issuer’s creditability before deciding on the bond type.
It is important to have a diversified portfolio to generate the best returns from available funds. This aids in meeting your financial goals. At the same time, it is important to take into account your appetite and willingness to take a risk. You may hire a professional financial advisor for creating a personalized portfolio as per your investment preference. A financial advisor can advise you on the proportion of different asset classes required to achieve your goals. Consulting the advisor equips you to take an informed call and choose the most appropriate bond for investing. It also helps in combating the associated risks to make the maximum possible returns.
