Bonds, depending on their maturity period and risk level, offer varying returns. For instance, a typical medium-term investment-grade bond might yield an annualized return of about 3% to 6% (the yield is influenced by the current benchmark interest rate and the bondโs risk level). In the long term, the overall return is usually slightly lower than stocks, but it is more stable, and the price risk fluctuation is relatively smaller. Generally, the price volatility in the stock market is about 2 to 3 times greater than in the bond market. However, some high-risk bonds, such as junk bonds, may have volatility levels closer to the stock market.
1. Advantages of Investing in Bonds
Fixed Income (Regular Interest Payments): Bonds, similar to fixed deposits, are an investment tool that generates regular interest income.
Lower Risk Volatility (Above Investment Grade): Compared to stocks, bonds have lower risk volatility (this discussion mainly refers to U.S. government bonds or bonds with high ratings). Itโs important to note that not all bonds are safe.
Increasing Asset Stability: Through asset allocation, investing in different types of asset classes can help control risk. Bonds play a complementary role here, balancing out high-risk positions like stocks. When stock market risk is high, funds tend to flow towards bonds, reducing the overall asset volatility through bond allocation.
2. Risks of Investing in Bonds
Default Risk: The primary concern in bond investment is default risk. If the issuing country/company cannot pay the interest or principal, a bond default occurs.
Interest Rate Risk: Interest rates and bond prices are mostly inversely related. When interest rates rise, bond prices fall. Interest rate fluctuations are one of the main reasons for price volatility in the bond market.
Maturity Period: Longer maturity periods usually indicate higher uncertainty in repayment.
Market Sentiment: Bonds can be held without selling, earning fixed interest, but their market value still fluctuates with market sentiment. Bond prices are generally stable, but during the panic, safe bonds might rise in value, while some high-risk bonds might plummet.
Liquidity Risk: If a bond has low trading activity, with few buyers and sellers, it can lead to a situation where it has value but no market, making it hard to convert to cash quickly. For instance, during a panic, many people might want to sell simultaneously, possibly leading to significant short-term discounts.