Why People Invest in Bonds
Ultimately the reason people invest in anything is to earn a return on their investment, and bonds are no exception. Bonds as an asset class offer several unique attributes that make them attractive to a wide variety of individuals.
To earn a predictable stream of income: While there are exceptions, bonds pay a fixed rate of interest, at regular intervals, and on pre determined dates. The income stream that you earn when buying a bond is predictable. Come rain or shine, as long as the issuer of your bond doesn’t go bankrupt, you get your interest payment. Generally interest is paid every 6 months but there are variations depending on the type of bond you buy.
To diversify their portfolio: Bond prices and stock prices tend to move in opposite directions. When bond prices are rising, often the stock market is performing poorly, and vice versa. Because of this “lack of correlation” many investors who hold a lot of stocks in their portfolio, will add some bonds into the mix to cushion the blow if the stock market does poorly.
Tax Savings: As we discuss in greater detail in our lesson on bonds and taxes, certain bonds, such as Treasury and Municipals, offer some unique tax benefits which include not having to pay federal, state, and or local government taxes.
Interest Rate Speculation: As we discuss in greater detail in our lesson on interest rates, one of the largest factors that affects the price of a bond is movement in interest rates. As many types of bonds are very sensitive to changes in interest rates, often times individuals find them a good instrument to speculate on the future direction of interest rates.