Benefits of Investing in Bonds

One of the most important advantages investing in bonds offers, especially in today’s volatile economy, is portfolio diversification. While most investment news is covered up by stocks, bonds offer unique benefits that provide solace and predictable returns aiding in the diversification of the portfolio. 

In this blog, we will further understand the benefits of investing in bonds and see how it can improve and protect your investment portfolio.

Reasons to Invest in Bonds

Bonds are said to be one of the safest investment avenues for people who are seeking stability and consistency in their portfolio performance. Bonds are debt instruments where the investor (bond buyer) lends money to the bond issuing entity that can either be a government or corporation in exchange of interest payments at regular intervals and the return of principal amount at maturity.

When you buy a bond you become a creditor to the issuer as you get the principal amount at the time of maturity along with regular interest payments or coupon payments. Coupons are generally distributed annually or semi-annually providing you a risk-free stable income. 

Read Also: Detailed Guide on Bond Investing: Characteristics, Types, and Factors Explained

Top Benefits of Investing in Bonds

A list of top benefits of investing in bonds are:

1. Stable and Predictable Income

People who invest in bonds enjoy the benefits of steady income. Like clockwork, bonds pay fixed interest at pre-defined intervals and this makes them suitable for retirees or anyone looking for a passive income source. Most of the government and corporate bonds in India offer interest rates between 8% to 11% per annum.

2. Capital Preservation

Bonds are excellent for preserving capital given that they repay your principal at the set maturity date. These are particularly suitable for those wanting to avoid the ups and downs of equity markets or nearing retirement. While you may face wild fluctuations in investment value when it comes to stocks, bonds are less volatile and provide more security.

3. Portfolio Diversification

Bonds mitigate risk and adding them to your portfolio can prove beneficial. Since bonds are not correlated to equity returns, they lower overall portfolio risk, providing protection during stock market slumps. You can invest in bonds issued by different types of issuers such as government, corporate, or municipal to further diversify your portfolio. 

4.Tax Benefits 

In India, some bonds provide tax-free returns. For instance, certain government-issued bonds offer tax-free interest income, making them popular among investors. 

5. Aids in Nation-Building and Development of Businesses 

Purchasing government bonds helps you contribute to the funding of infrastructure projects like building roads, schools, and bridges. Corporate bonds contribute to business growth, rise in employment opportunities and economic development.

6. Shield Against Inflation 

Certain types of bonds, such as inflation-indexed bonds adjust the maturity amount according to inflation, which protects investors against inflation. This maintains the buying power of the returns earned. 

Read Also: What are Bond Yields?

Things to Consider Prior to Making Investments in Bonds

Like many other forms of investments, bonds also come with risks that have to be considered beforehand. While their reputation may suggest safety, there is a lot more under the surface. The most prominent risks to consider are :

1. Interest Rate Risk

Interest rates and bond prices have an inverse relationship, meaning that when interest rates increase, prices of existing bonds tend to decrease. This happens due to new bonds offering better yields, thus lowering the value of older bonds in the market.

2. Credit Risk (Default Risk)

This is the risk describing a scenario in which the bond issuer might fail to give interest payments or repay the principal amount at maturity. Bonds issued by famous companies and governments are safer, while corporate or junk bonds carry a higher credit risk. 

Tip: Use the bonds credit rating from CRISIL, ICRA, etc to analyse the credit risk of the bond. They all provide reliable ratings and can help you make a better investment decision.

3. Inflation Risk

Inflation is referred to as a general price rise in an economy, this means that with time the price of goods and services increase leading to a decline in the purchasing power of money. In other terms, each rupee will buy less amount of goods and services today than in the past. 

In case inflation rate shoots up sharply, then the bond returns will be lower in real sense. Example : If a bond pays 5% interest every year but inflation is 6%, then your real return is negative. 

4. Liquidity Risk

The bonds may have been listed on the exchange but there may be no liquidity, which means that there may be no buyers at the time when you wish to sell and vice-versa. If you value liquidity, stick with government bonds or high-rated corporate bonds. 

5. Call Risk

Certain bonds have a call option, which allows the issuer to retire a bond before its maturity date, usually if interest rates decrease. This is a plus for the issuer, but a disadvantage for investors who lose potential interest earnings and now may want to reinvest the amount at reduced interest rates.

Read Also: Stocks vs Bonds: Difference Between Bonds and Stocks

Some popular bonds that Indian investors can invest in are as follows :

1. Government Bonds (G-Sec) – These are low-risk bonds that are issued by the Central Government and are considered the safest investment option. 

2. Corporate Bonds – These bonds are issued by the private companies to raise funds/capital and these bonds typically offer high yields due to credit risk associated with them. 

3. Tax Free Bonds – The interest earned by the bondholder is exempt from taxation in these bonds.

Conclusion

All investors can enhance their investment portfolios by investing in bonds. These securities provide numerous benefits, such as stable income, protecting capital, and portfolio diversification. Even though their returns are often lower than equities, bonds are less risky and provide steady income to conservative investors. Understanding the various benefits and factors affecting bond investments allows investors to align their investment decisions with their financial aspirations. It is advised to consult a financial advisor before investing.

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