Why are bonds popular again? If the potential to earn a regular income with less risk than traditional investments sounds interesting, you’re going to want to learn more.
Bonds are the world’s most traded asset class, with a global estimated worth of around $130 trillion. Although they fell sharply out of favour with investors in recent years when hit by the double whammy of record low interest and high inflation, now the tables have turned.
Bonds are making a comeback, and with good reason. They have the potential to earn you a regular income with less risk than traditional investments. Let’s look at why many financial analysts as well as investors are getting excited about bonds again. Here are three things you probably didn’t know about bonds!
1. When interest rates rise, it can be a good time to invest in bonds
Bonds are a type of fixed-income investment, with interest paid regularly (usually monthly) to the investor until maturity. For the last several years, the interest rates paid on bond coupons have been very low, because interest rates in general were at rock bottom.
However, that is changing. Central banks around the globe have been raising interest rates to counteract high inflation. And although interest rate hikes have negatively affected the stock market, they’ve been a boon for bonds. While the returns you can get at your bank are still low (only around 1.45% on average in the UK), bonds can pay you from 4% and up, and will continue to do so if held until maturity.
2. Bonds can be invested in indirectly — and there are key advantages to doing so
Bonds are already considered lower risk than most investments. But investing in bond ETFs offers the additional benefits of diversification, since they hold a variety of bonds issued by different entities.
A risk that is associated with bonds is default risk, which is when the issuer fails to make payments. The familiar risk management strategy of diversifying exposure with many instruments also applies here, as the variety in bond ETFs reduces the impact of any single bond defaulting, if that should happen.
Another advantage to investing in bond ETFs is that they require far less capital than individual bonds. Bond ETFs also offer what is known as liquidity — they can be bought and sold throughout the trading day, just like stocks. So, rather than having to commit to holding it until the bond matures, investors can quickly and easily adjust their exposure to the bond market at any time.
The Vanguard Total Bond Market ETF (BND) is the world’s largest fixed-income fund with over $80 billion of assets. This fund invests in a very diverse range of highly rated US bonds, making it an excellent choice for investors seeking high-quality, diversified exposure to the vast US bond market.
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3. Like stocks, higher risk bonds can mean higher yields
Corporate bonds are issued by companies, rather than by governments. They may, therefore, carry credit risk, unlike government bonds which are considered very safe. However, to compensate for the increased risk, they offer higher yields.
Pay extra attention to a corporate bond’s ratings, which help to evaluate the default risk. The highest rating is AAA; bonds rated Ba1/BB+ or lower indicate particularly high risk.
Corporate bonds still carry less risk than stocks — and when you invest in a variety of them together as an ETF, the risk is reduced even further due to diversification. The iShares iBoxx High Yield Corporate Bond ETF (HYG) could be a great option for those who are willing to take on a little more risk (but still lower risk than some other high-yield investments or individual corporate bonds) in exchange for greater reward.
77% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.
It’s important to remember that, like any investment, bonds do carry risks. However, when compared to assets such as stocks, commodities or forex, bonds generally carry lower risk. Always check a bond’s rating to assess the issuer’s credit risk. For more on the benefits and risks of bond ETFs, read our guide to fixed-income investments here.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 77% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.