Investing in bonds is a popular strategy for building a diversified investment portfolio and generating income, but there are several myths and misconceptions surrounding bond investing that can mislead investors. Here are three common myths about investing in bonds.
Bonds Are Always Safe Investments
While bonds are generally considered safer than stocks due to their fixed-income nature and lower volatility, they are not risk-free investments. One common misconception is that all bonds are safe, regardless of the issuer or credit quality.
In reality, the risk level of a bond depends on factors such as the creditworthiness of the issuer, interest rate changes, and economic conditions.
Bonds issued by governments or highly-rated corporations (investment-grade bonds) are generally considered safer than bonds issued by lower-rated companies (high-yield or junk bonds).
Investors should carefully evaluate the credit risk of bonds and diversify their bond holdings to mitigate risk.
Bonds Only Offer Low ReturnsÂ
Many investors believe bond returns lag far behind stocks. While equities carry a higher upside, bonds still provide meaningful income.
Today’s 10-year US Treasury Notes pays 4%, according to TreasuryDirect.gov. According to the St. Louis Federal Reserve, high-quality corporate bonds yield an average of 5.10%.
While you may not get the double-digit returns you’ll find with stocks, bonds offer much more reliable returns that can still beat inflation. Bonds also offer stable cash flow through regular interest payments.
This makes them a good option if you want income from fixed payments. Plus, reinvesting interest can accelerate your overall return on investment.
Bonds Always Provide Fixed Returns
Another myth about bonds is that they always provide fixed returns. While bonds typically pay a fixed interest rate (coupon) over the life of the bond, the total return on a bond investment can vary depending on changes in interest rates and market conditions.
When interest rates rise, bond prices generally fall, and vice versa. This relationship, known as interest rate risk, can impact the value of a bond investment, especially for long-term bonds with fixed interest rates.
Investors should be aware of interest rate risk and consider the potential impact on their bond portfolio when interest rates change.
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Rising Interest Rates Mean Falling Bond PricesÂ
This common myth often keeps investors from bonds during Federal Reserve rate hike cycles. However, higher rates predominantly impact the prices of existing bonds versus newly issued ones carrying higher coupons, according to Fidelity.
New bonds provide the same relative return even as rates go up. If you adopt a laddered bond strategy with varied durations and staggered maturities, your interest payments can get reinvested into higher yields.
Plus, once your bond matures, you’ll receive face value back and can reinvest the money at improved rates. So, rising rates don’t undermine bond portfolio performance over longer periods.
Bonds Are Not Suitable for Young Investors
Some investors believe that bonds are only suitable for older investors seeking income and capital preservation, while younger investors should focus solely on stocks for higher returns.
While stocks historically have higher long-term returns than bonds, bonds can still play a valuable role in a diversified investment portfolio for investors of all ages.
Bonds provide stability and income, which can help offset the higher volatility of stocks and reduce overall portfolio risk.
Additionally, younger investors may use bonds to achieve specific financial goals, such as saving for a down payment on a house or funding education expenses, with a more conservative investment approach.
You Can’t Lose Money in a Bond
While generally less volatile than individual stocks (and even mutual funds), bonds carry some risk.
With individual bonds, you could lose money if the issuer defaults. This is less of a risk with Treasury bonds, which the U.S. government backs.
Bond funds also fluctuate in price based on interest rate changes and economic conditions. So, while high-quality bonds provide relative stability, they are not risk-free and do not guarantee no losses.
