Thursday, 25 June 2009

Shortcomings of Bonds

A bond is a contractual agreement that means you have loaned money to some entity, and that entity has agreed to pay you a certain sum of money (interest) every six months until that bond matures. At that time, you will also get back the money you originally invested - no more, no less.

The two advantages of bonds are safety and income.

If you wait until the maturity date, you will be assured of getting the face value of the bond.

In the meantime, however, the bond will fluctuate, because of
  • changes in interest rates, or
  • the creditworthiness of the corporation.
Long-term bonds, moreover, fluctuate far more than short-term bonds.

Bonds don't have a particularly impressive record.
  • Except for a year here or there, common stocks have always been a better place to be.
  • Furthermore, the return on bonds today is not much better than the rate you can get on a money-market fund.

Also, bonds, even U.S. Treasuries, have an element of risk.

  • They decline in value when interest rates go up.
  • Long-term bonds, moreover, slide precipitously when rates shoot up.

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