5 Pros and Cons of Buying US Bonds

 In Bond Investing

US Bonds

Investing is an important tool for growing wealth, but with so many options for where to put your money, it’s easy to feel overwhelmed and unsure of where you’ll get the best result.

Bonds have always been a great investment vehicle with countless people swearing by them for centuries. Lately, investors have been really flooding the U.S. bond market too.

Does that mean it’s a good place to put your money?

Let’s take a look at five pros and cons to help you decide.

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The Pros of Buying US Bonds

They’re a Safe Haven for Your Money

Inexperienced investors are always on the lookout for new ways to make their money start multiplying fast. This is a bad attitude to take with investing though and usually ends after the person has chased one too many “sure things” and is out of funds.

While it’s fine that you want to invest your money to make more of it, you should also be prioritizing vehicles that will keep those funds safe too. Bonds basically represent an investment in another party’s debt, which is generally a much safer choice than investing in someone’s equity.

Think what happens when a company goes bankrupt. Shareholders can get in line, but they’ll have to stand behind those who are creditors (those who own debt). Sure, this isn’t an ideal scenario, but at least you stand a better chance of getting some of your money back.

Steady, Predictable Returns

As we just touched on, if you’re investing for quick returns of massive piles of cash, you’re doing something wrong. That’s just not a realistic approach. Bonds, on the other hand, are all about consistent returns.

This is the reason a lot of retirees prefer US bonds. There’s very little risk involved to worry about. At the same time, they’re not a bad idea for a young person’s portfolio in order to add some security.

At the same time, they’re not a bad idea for a young person’s portfolio in order to add some security.

Feature of Maturity

Individual bonds have a unique feature: maturity. Each issuer has an obligation to pay a “par value” back to investors at maturity.

Investors who use individual bonds in their portfolios don’t only receive predictable returns, but get invested principal back by a defined time horizon.

This differentiates individual bonds from bond funds, which have no maturity at all.

Individual bonds portfolios are good for those investors who need to invest money with a defined time horizon. Such instances include saving money for buying a house, a child’s education or retirement.

They’re Better than Banks

Furthermore, savings accounts aren’t all they’re cracked up to be.

Bonds will usually provide you with a better interest rate, which is important for staying ahead of inflation. When you factor in the level of stability we just covered, you get the best of both worlds: security and growth.

Have a look at an example: Wells Fargo savings accounts offer interest rates of only 0.01%. Their CD with 58 months offers an interest rate of 0.5%.

Now, look at the Wells Fargo’s bond WFC 0.250% 06/24/20122with a six-year maturity timeline that provides a yield to maturity of 3.25%.

US Bonds Still Provide Yields over Treasuries

Although there is also a lot to be said for treasuries, bonds take much longer to mature which adds to the stability we mentioned earlier and, of course, their payouts. Depending on your portfolio,

Depending on your portfolio, age, and goals, buying treasuries may still make a lot of sense, but US corporate bonds are still a high-performing investment vehicle that currently provides better yields than this other popular alternative.

A recent buying spree of central banks and other institutional investors tumbled bond yields to a historical record low. In addition, $13 trillion of global bonds are currently providing a negative yield. However, many US investment grade corporate bonds still provide an

However, many US investment grade corporate bonds still provide an attractive yield above the level of inflation.

That being said, there is never a perfect choice for investing. Even US corporate bonds have their weak points, which is why it’s also worth considering the:

Bond Investing Fundamentals

Cons of Buying U.S Bonds

Default

There’s always the chance of an issuer defaulting and leaving you with nothing for your investment. Fortunately, if you’re buying U.S. bonds backed by the U.S. government, this is pretty unlikely. Of course, this is why this option has always been so popular.

Fortunately, if you’re buying US bonds backed by the US government, this is pretty unlikely. Of course, this is why this option has always been so popular.

It’s still worth pointing out, though, lest you think that all bonds are going to be as reliable as those from our government. While you may still wish to buy other bonds, make sure they’re just a part of your diversified portfolio and not the whole thing.

While you may still wish to buy other bonds, make sure they’re just a part of your diversified portfolio and not the whole thing.

Rising Interest Rates and Inflation

The price of bonds generally falls with the rise of interest rates. That being said, if you keep a bond until its maturity date and the issuer pays back the entire amount of the principal and does so on time, inflation probably isn’t going to be too much of a problem.

The doomsday scenario that keeps bond investors up at night would be a situation that involves rampant inflation.

At the moment, it doesn’t look as though this outlook is something to worry about and probably won’t be anytime soon. With the Fed keeping rates low and good reason to think that this will continue, inflation probably won’t be affecting US bonds for a very long time.

Furthermore, even when inflation does kick in and interest rates hike, most investors should hold bonds until maturity and ignore market price volatility.

Holding bonds to maturity protects you from any interest rates rise.

Call

Here’s one aspect of bonds that is definitely worrisome and needs to get brought up so you’re not caught by surprise.

If a bond is callable, that means the issuer can basically decide that you have to redeem it early, regardless of other circumstances. That would be like a company forcing a shareholder to sell their stock.

Typically, you will only be allowed to redeem it for face value too. This even applies to those who paid more than face value. That premium basically evaporates.

If you didn’t pay above face value, you’re lucky, but are still going to miss out on the potential gains you had probably been hoping for.

Downgrade

Another pitfall of bonds is that they can drop in price quickly if the issuer is dealt a negative rating by an agency.

These agencies play an important role in the market by critiquing issuers and publicizing their reports.

The problem is that even if you’re very interested in the bond market, you may not be able to do your own research in time to avoid buying a bond that’s about to suffer from a downgrade.

While a downgrade is nothing to look forward to and it affects bond prices, it is not the end of the world. If you would buy a bond with the intention of holding it until maturity, you are protected from such events unless an issuer defaults.

Liquidity

Finally, bonds aren’t very liquid. Stocks are a far better route to take if liquidity is a priority because there is always someone willing to buy.

With bonds, you may want to sell, but may not have a lot of buyers who are interested. Not only will this hurt your hopes of getting your hands on cash, it may also mean you have to accept considerably less than what you had been hoping for.

Hint: buy bonds with the intention of holding it until maturity. Do not try to trade bonds.

By now, you should have a better understanding of US bonds and why so many people continue to love them.

As Ford O’Neil, the Manager of Fidelity Total Bon Funds recently said:

“I also like investment-grade credit. There, my outlook is changing. I have been favoring financial companies, which have posted strong results for the past seven years. But as the bonds of these companies approach their fundamental fair values relative to history, I am considering undervalued opportunities in the industrial sector.”

While US bonds are no guarantee of profits, they continue to be one of the safest places to keep your money for consistent growth.
Bond Investing Fundamentals

Sergey Sanko
Sergey had started an IncomeClub after years of being an investment advisor for high affluent investors and managing fixed income securities. He is the lead investment advisor representative and holds a Series 65 license. Sergey earned his Executive MBA degree from Antwerp Management School.
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