Are bonds bad investments? What are the disadvantages of investing in bonds? Well, I advice you read on to find out.
A bond is defined as a financial tool, more particularly a debt investment whereby a person known as the investor loans money to a borrower, provided that the latter pays the entire sum of the principal plus fixed interest at a fixed or determinable future date. Bonds are financial instruments used by different entities such as private for profit corporations, the national government, local government units, municipalities, etc. both local and domestic in order to raise revenues to finance various projects or ventures.
Simply put, investing in bonds is a way by which a person invests money by lending the same to another, to be paid at a specific or specified interest rate on a specific or determinable future date. However, it is a known fact in the investment world that every investment vehicle or product has its good and bad side. This article will discuss the disadvantages of investing in bonds, but my aim is not to dissuade you from investing in bonds; rather, it is to provide you with information to better understand bonds as an investment option as well as formulate a plan of action to minimize its disadvantages.
Why Bonds Are Bad Investments – 3 Disadvantages of Investing in Bonds
Bonds have a fixed rate of return that is commensurate with the type and risks involved. For example, if you want lower risks, you invest in treasury bonds with the government’s guarantee but have low interest rates. However if you want a higher return rate, you need to invest in riskier types of bonds such as high-yield bonds. Therefore you need to balance the risk you are willing to take with that of the returns you want to earn. A good way to do this is to invest in both high risk and low risk bonds and then transfer income and loss one way or the other until you get the hang of things and are ready to move onto bigger or riskier investments.
Risk of Loss
As stated earlier, substantial income can only be earned in the long run or in the short run if you invest heavily on high risk bonds. This creates a premium or a high pressure to deal in such types of bonds, which can result in substantial losses. This is especially true for beginners who fail to fully grasp investment techniques and rely heavily on their stock or bonds broker who in turn is inclined to invest in risky types of bonds.
Not to mention the fact that in today’s economy, a particular corporation within which bonds are tied down to can rise or fall really fast. This means investments cultivated over the years can be lost in a matter of days. Worst, there is no adequate insurance like the FDIC to minimize the loss to the investor.
The cost of keeping your investments in check is not cheap. This is because you either pay commission to a broker to look after your interest or you do it yourself. The former means paying money or surrendering a certain percentage of the investment income while the later means opportunity costs on your part in concentrating on the investment rather on other matters.
In conclusion, I want to stress categorically that there are no bad investments, what we have are bad investors or gamblers that invest without sound investment knowledge. Remember, that more important than profits from an investment is your financial intelligence or soundness.