The characteristics of bonds:
1. The level of interest rates set by the government are somewhat predictable
2. They are not as risky as stocks.
Many people point out that stocks outperform bonds in the long run. Perhaps. However, one comfort you do have with high-grade bonds is that you are unlikely to wake up in the morning and find you have lost 25% of your investment, which of course does happen occasionally with stocks.
Most unexpected shocks to the economy are bad news:
- a crash in consumer or business confidence,
- a terrorist attack,
- a war,
- a SARS crisis, etc.
In the 1987 October share crash, panic was everywhere. Those who were holding bonds did very well. The bad news for the economy was good news for interest rates.
There is also the interesting effect of government deficits on bond yields, especially in the United States.
- One could argue that the government bond markets should work like all markets, so that if the government wants to borrow more and more, it has to pay a higher interest rate, and sell bonds at a lower price.
- This was a criticism of fiscal policy by one brand of economists - the monetarists. They argued that 'crowding out' would mean that higher deficits don't help a weak economy, because they simply push up borrowing costs for everyone.
- However, current interest rates in the US are normal even though the deficit is at an all time high, therefore such an argument is not convincing.
As an investor in the stock market, bonds are alternatives. There have been dream runs in the share market. This article alerts you to the attractions of the bond market when your strategies steer you in that direction.
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