Bonds are fixed-interest securities issued by governments, local authorities, companies and other entities in order to raise capital. The buyer of a bond essentially lends money to the issuer and in return receives interest payments over a certain term as well as repayment of the nominal value of the bond at the end of the term.
Possibilities:
- Income generation: Bonds are attractive to investors seeking a regular and predictable income as they offer fixed interest payments over their term.
- Diversification: Bonds often have a low correlation to equities and can therefore contribute to the diversification of an investment portfolio.
- Security of capital: Bonds, especially government bonds and high-quality corporate bonds, are considered less risky than equities, making them a safer investment option.
- Inflation protection: Certain types of bonds, such as inflation-indexed bonds, offer protection against inflation as their interest payments are adjusted to the inflation rate.
Advantages:
- Stability and predictability: Bonds tend to be less volatile than equities and offer fixed redemption periods and interest payments, making them a stable source of income.
- Capital preservation: At the end of the term of a bond, the originally invested capital (the nominal value) is repaid to the investor, unless the issuer defaults.
- Priority in the payout: In the event of liquidation or insolvency of the issuer, bondholders generally have priority over shareholders when it comes to payout.
Disadvantages:
- Interest rate risk: Bond prices move inversely to interest rates. When interest rates rise, bond prices fall, which can lead to capital losses for the investor if he sells the bond before maturity.
- Issuer risk: There is a risk that the issuer gets into financial difficulties and is unable to pay interest or repay the capital on maturity.
- Inflation risk: The fixed interest payments on bonds can lose value over time if inflation rises, reducing real returns for the investor.
- Liquidity risk: Some bonds can be illiquid, especially if they are from smaller issuers or have longer maturities, which can make it difficult to buy or sell at a fair price.
- Call risk: Some bonds have call provisions that allow the issuer to redeem the bond before maturity, often to the detriment of investors.
Bonds can be an important component of a balanced investment portfolio, especially for those seeking regular income or lower volatility. However, as with all investments, it is important to understand the risks and the context of the overall market in which you are investing.
