Why invest in bonds?

Firstly, what are bonds?

Bonds are loans that investors grant to corporations and governments, as these are the main types of bond issuers and have different risks. Bonds have a coupon which represents the right the bondholder has to claim and receive interest, unless it is an interest-free, also called zero coupon.

In case of a company’s bankruptcy, the bondholders are one of the first stakeholders to be paid back, even before shareholders, who usually are the last ones to be paid back, as they are debtholders and not owners of the company.

So, what’s the perfomance?

The bond market is not know for its incredible returns just as the stock market presents, but it is widly considered as a conservative approach and complement to any portfolio due to its low volatility and rights of debtholders as mentioned before. Bond rates tend to be higher when the interest rates such as the EURIBOR, LIBOR and the Fed rate are higher, and vice-versa.

The returns from the bond market take two forms: interest and capital gains. Interest are payments for the usage of capital borrowed from the debtholders, just like mortgage interest, for example. The period in which the interest is paid can vary from bond to bond, and so does it rate. Capital gains refers to the variations in market price of the bonds held, be it realized when the bond is sold, or unrealized when it’s the difference between the current price and the acquisition price.

In conclusion

Bonds are a less risky security risky security compared to other instruments such as stocks, futures and options, but all of them have their own specific risks that should be accounted for. For it’s good returns and compareble less risk, bonds occupy a significant part on every diversified portfolio, balancing.

Successful investing is about managing risk, not avoiding it

Benjamin Graham, author of The Intelligent Investor