Stocks and bonds are popular ways to start building your wealth. Though you can earn the right amount of return by investing money on stocks, they are highly volatile and, therefore subject to high risk. If your risk capacity is not high, bonds will be a better option.
A bond is a fixed income investment, often called a loan to a company that allows you to earn interest. They are safer than stocks, so the interest you receive by signing bonds will likely be lower than dividends.
You can either hold bonds until maturity and collect interest payments or sell them at a higher price when the market value increases. The prices of bonds go up under two circumstances:
- The credit risk profile of a company has improved, and
- When interest rates on newly issued bonds go down.
Bonds are a safer investment than stocks, yet you should need to know several things about investment bonds.
How do bonds work?
Buying a bond means lending money to a company, also called a bond issue that promises you to pay back interest. Interest rates on bonds are usually low, and therefore, they are less attractive to potential investors. How much interest you will earn depends on the term of the bond. Companies typically pay interest twice a year. However, some companies pay it annually and quarterly. Interest rates vary from the length of the loan. The higher the term, the higher the interest will be. Once the bond matures, the company repays the face value of the bond.
When you invest in stocks, you earn a dividend and get partial ownership of the company. Stocks are riskier investments. If you cannot afford to take the risk, you should not invest in shares. Bonds are subject to the fixed interest rate. Companies decide the interest rates based on market conditions. If you have never bought a bond before, you should invest in a 1-year bond. You will get an idea of how much you will be able to earn.
What are the types of bonds?
There are different types of bonds, and each bond works differently. Before investing in any bond, you should know the difference between all of them.
Irish government bonds
These bonds have a little capital risk, but the interest rates will be low. When you get the money on the maturity of the bond, it will have less buying power due to inflation risk. Government bonds also include bonds issued by states, cities, and other government local bodies. The money is raised to fund public projects.
As the name suggests, these bonds are issued by companies. Corporate bonds offer better interest rates than government bonds, but you need to be careful. Make sure that you are buying bonds from a reputable company that is not likely to default.
Benefits of bonds investment
- Bonds are safer investments. They do not tend to fluctuate like stocks. As they are not as volatile as other investments, they are subject to low risk. However, the return will be low.
- Since bonds offer fixed interest semiannually, you know how much money you are going to make. Unlike shares, they are predictable.
- Investing in government bonds will be a better idea as there is no risk of default. The government is more promising than companies.
Drawbacks of investing in bonds
- Bonds are subject to inflation risk. The money you get on the maturity of the bond will have less buying power.
- If you buy a long-term bond, you block your money. It loses chances of making money by investing in other assets.
- Bonds are not traded publicly, and therefore you do not get to know if you are getting a fair price. Over the counter, trading can lead to the broker charging higher rates. However, you do not need them to buy government bonds.
Is it a good idea to invest in bonds?
There is no hard and fast rule to jump to the conclusion. It depends on your financial circumstances and investment goals. If you cannot afford to bear risk, you should invest in bonds as they carry a fixed interest rate.
However, bonds are also an excellent way to diversify your investment portfolio. Throwing the entire money at stocks can be extremely risky even though your risk appetite is very high. Invest in different types of assets can mitigate the losses in case the market goes down.
To summarise, investing in bonds is not a bad idea regardless of your risk appetite. You can make money without bearing high risk, and you can diversify your investment portfolio. If you are a novice to the investment world, it can be a good idea to start with bonds investment