Bonds come after stocks in the ranking when it comes to the top choices for investors’ investments. Surely, the stock market offers a lot of great perks and benefits that make most investors choose it over bonds. However, bonds are almost as popular as stocks for good reasons.
Bonds are a safe haven
Think about stocks and bonds as equity and debt, respectively. Bonds are debts while stocks represent ownership of equity. This implies that in general, investing in debt is better than investing in equity. That’s because debtholders are generally prioritized over shareholders.
For instance, if a company goes out of business, debtholders or the creditors rank first ahead of shareholders when receiving payments. In the worst case scenario, the creditors commonly obtain at least some of their money back, while shareholders usually lose their whole investments.
When it comes to safety, the bonds from the US government (Treasury bond) are considered to be risk-free, whereas there’s no such thing as a risk-free stock. Even though they don’t yield a really high return, a stable government’s bond is what you need if your goal is capital preservation, which refers to never losing your principal investment.
On the flip side, keep in mind that even though bonds are safer in general, there are still risky types of bonds called junk bonds, and you should avoid them.
History has proven that stocks can outperform bonds in the longer run. On the other hand, bonds outperform stocks at specific times in the economic cycle. It’s not unusual for stocks to shed 10 percent or higher in just a year. That means if bonds make up a portion of your portfolio, they can make up for the bumps when a recession comes along.
In addition, there are certain situations in life where you may need security and predictability. Take the case of retirees for example. By owning bonds retirees are able to know in advance with a greater degree of accuracy how much income they will have in the future. An investor who is still decades away from retirement has plenty of time to make up for any losses from periods of decline in prices.
Better than banks
There are times when bonds are the only decent option. The interest rates paid on bonds are normally higher than the interest rates paid by banks on a savings account. As an outcome, if you are saving and you don’t need the money in the short term, which may be a year or less, bonds will offer you a relatively better return without incurring too great risks.
A good example of the funds that you want to increase through investment while also protecting from risks is college savings. With the usage of bonds, aspiring college students can forecast their investing earnings and determine the amount they will have to accumulate in their college tuition nest egg by the time school starts.