Benefits of Investing in Bonds

Investment

Bonds

Investment benefits of investing in bonds

By: Thomas Kenny

Updated on February 4, 2022

Reviewed by: Robert C. Kelly

Mr. Robert Kelly is the CEO of XTS Energy and has over three decades of experience as a business executive. He is a professor of economics and has raised over $4.5 billion in venture capital.

1. Bonds provide income

While many investments provide some form of income, bonds tend to offer the highest and most stable cash flows. Even during times when rates are low, there are still many options you can use to build a portfolio that meets your income needs. These could include high-yield bonds or emerging market debt.

Most importantly, a strong bond portfolio can provide good returns with a lower level of volatility compared to stocks. It can also generate more income than money market funds or bank instruments. This means that bonds are a good choice for those who need to live off investment income.

2. Bonds provide diversification

Everyone has heard the phrase “don’t put all your eggs in one basket.” This is very true for investors. It may be a familiar saying, but it is timeless wisdom. Over time, greater diversification can provide better risk-adjusted returns than narrow portfolios. In other words, diversification reduces the level of return relative to risk.

Importantly, bonds can help preserve capital for stock investors during periods of stock market downturns.

3. Bonds preserve capital

Fixed-income investments are especially useful for those who are approaching the point where they will need to use the cash they have invested. For example, this may apply to someone nearing retirement age in five years or a parent whose child is starting college. Stocks can experience significant levels of volatility in a short period, like the stock market crash in 2001 and 2002 or the economic crisis in 2008 and 2009, but a diversified bond portfolio is likely to incur significant losses in the short term.

As a result, it may be wise to increase your allocation to fixed income and reduce your allocation to stocks as you get closer to your goals.

4. Bonds provide tax advantages

Some types of bonds can also be beneficial for those who need to reduce their tax burdens. Income from bank instruments, most money market funds, and stocks is taxable unless the assets are held in a tax-deferred account, but interest on municipal bonds is exempt from federal taxes. If you own a municipal bond issued from the state you live in, it is also exempt from state taxes.

Income from U.S. government securities is exempt from state and local taxes. Tax reasons should not be the primary reason you choose to invest, especially if you are in a lower tax bracket, but the universe of fixed income provides a number of ways you can reduce your tax liabilities.

In conclusion:

Bonds do not make for exciting conversations at dinner parties, nor do they receive proportional coverage in the financial press compared to stocks, but they can be of great benefit to investors of all kinds.

Frequently Asked Questions (FAQs)

When are bonds a good investment?

Bonds are a good investment when the benefits mentioned here align with your primary goals. In other words, if your primary investment goals are to preserve capital and generate income, bonds may be worth considering. If, on the other hand, you are a young investor with a longer timeline who prioritizes capital appreciation, then bonds may not be worth your consideration.

What…

What are the benefits of long-term bonds compared to short-term bonds?

Long-term bonds offer higher returns than short-term bonds. There are additional risks associated with locking up investment funds for a longer period, so investors are compensated for those risks with more income.

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Sources:

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and keep our content accurate, reliable, and trustworthy.

U.S. Securities and Exchange Commission. “Municipal Bonds.”

U.S. Securities and Exchange Commission. “Government Securities.”

Source: https://www.thebalancemoney.com/why-invest-in-bonds-417083

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