Bouke van den Berg discusses the benefits and risks of investing in bonds.
In general, the most important advantage of investing in bonds is that they are relatively less risky than shares (stocks). In case of bankruptcy, a company must first repay bondholders and creditors and only then repay shareholders.
Of course, this lower risk also has a disadvantage: the risk premium linked to bonds is lower, which causes their expected return to be lower than that of shares over the long term. This means that if a company does well, the returns you enjoy with bonds probably aren’t going to be as high as the returns from shares. Bonds pay a set interest rate, while the value of shares grows as the value of a company grows.
There are two ways that you can achieve a return investing in bonds:
This is the return that is obtained from the periodic interest payments.
This is the return that is obtained when the market value of the bond increases. Reasons for this can be:
Note: As discussed above, the price return also can be negative. For instance, if the credit risk increases or interest rates increase, the price return could be negative.
Source: VanEck. The figure only considers the factors interest rates, price level and bond yields and does not take into account other criteria that could potentially negatively influence the bond price.