No love for bonds?
With exceptional volatility in stock markets, slower lending and higher borrowing rates, bonds should not be a taboo for young investors. In a survey conducted to find the best investment instrument for young investors by youngsters, none mentioned bonds as a viable investment opportunity.
65% of the people aged between 18 and 34 would prefer properties as their first major investment, stating stability and security as the rationale behind their choice. We also conducted another survey that asked adults over 35 on what they would recommend for younger adults.
66.7% of the people aged 35+ would recommend youngsters to invest in properties first, whereas 17% would recommend them to create a 6-month fall-back cash fund for emergencies before investing in properties.
Whether it was a lack of confidence or knowledge, we think bonds might be a little misunderstood and frankly underloved. With this in mind, we set out to enlighten you all on the pros of bonds and why they shouldn’t dismiss them so quickly.
Pros of Bonds in General
If you don’t trust the stock markets or are just looking for something that’s more stable than the latest and hottest stocks at your watercooler chats, bonds might be the answer. While stocks are ownership stakes in companies, bonds are essentially loans that you extend to companies. By investing a percentage of your portfolio in bonds, you are ensuring that you do not keep all your eggs in the same basket. They tend to be more stable than stocks and provide relative certainty.
Bonds come attached with a fixed interest rate that pays the bond holder on an annual or bi-annual basis. While companies are under no obligation to pay the stockholders with any dividends, bonds provide predictable returns which is perfect for anyone planning for their retirement or just looking for additional income.
Bonds come with a coupon rate which is the percentage of money that the issuer would pay the holder as interest on the loan, throughout the life of the bond. This interest income can be used to fund your extravagant lifestyle, satiate your appetite for riskier investments, or it could also form a part of the income you retire on.
Highly rated bonds from reputed companies and those issued by stable governments are easy to sell and convert to cash when needed. This provides you with the assurance that you would get your money when you need it. If you plan to hold the bond until maturity (i.e. the time at which the issuer agrees to pay the principal) you would get the totality of your principal back.
From 1980 to 2016, bonds yielded a positive return 34 out of 37 times, whereas stocks went up 31 out of 37 times (based on USA markets). Stocks generally provide higher returns over longer duration and that they are volatile. On the other hand, bonds are relatively more stable and are known to provide positive returns even in bad market conditions. The graph below perfectly visualises this phenomenon.
Fun fact: Apple holds $148 Billion worth of corporate and treasury bonds, making it the biggest accumulator of bonds in the world. When the biggest company in the world decides to invest 58% of their cash pile in bonds, there must be something attractive.
You must be asking what happens when the issuer goes bust or refuses to pay? Well, if the company goes bust, it starts selling its assets. The remuneration is paid in such an order that structured bond holders get paid first (the highest class of bonds), then the holders of unsecured and subordinate bonds are paid, and if something remains it is distributed amongst the shareholders (so much for being an owner).
Still not convinced?
What would you choose were you given a choice between a diamond and a bottle of water? You would pick the diamond, and this is because you are taking into account the exchange value of the product in account.
Assume a situation where you are in a desert; if you are like most people, you would choose the bottle of water over the diamond, and this represents the use value of the product. This is defined as the ‘Paradox of Value’, first brought forth by Adam Smith in the 1700’s. Consider another scenario where you are in a desert but you get to make the same choice every 15 mins. You would first choose enough bottles of water that can last you the whole trip and then take as many diamonds as you can carry!
In a similar fashion, the following two cases represent examples where the value of low risk investment and ability to liquify investments at will is higher than the opportunity cost of investing in stocks and holding over a long duration of time.
Example Case Studies
Case 1: Say you are saving to buy a new car in the next couple of years. You carry this out by putting aside a share of your monthly income in a bank account. The bank would then pay you a small interest on whatever you accumulate over the course of the years. Since you have a fair idea of time frame and the amount you would require, you could invest in bonds instead. Not only would this provide you with a better interest rate on your savings, bonds are fairly liquid instruments as well and can be readily converted to cash when needed.
Case 2: Assume you are saving for your child’s college fund and thus, you can’t invest the same in risky instruments. However, instead of saving in a bank account you could put the funds in bonds, reap benefits of higher interest rates and calculate with fair certainty how much you would need to save in future to accomplish your goals. Additionally, you can liquify the investments as and when needed.
That’s All Folks
Phew – bonds are quite useful under certain circumstances, and might be more suitable depending on what you’re looking for. Want to know more? Come ask us on our platform and you’ll get quality answers!
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