Podcast Episode 350: Are Bonds a Safe Investment?

The bond market is often touted as a haven for investors seeking stability and safety. Yet, as with any investment, it is fraught with nuances that can make the difference between a secure addition to one’s portfolio and one with unexpected downside. To help provide clarity on bonds and how they play into an investment portfolio, Jake Doser, CFP® joins the podcast to provide a foundational understanding for investors looking to harness their potential.

Bonds are essentially loans that investors make to entities such as corporations, municipalities, or the federal government. In return, the bond issuer promises to pay back the principal amount on a predetermined date, along with periodic interest payments. Despite their reputation as a safer investment compared to stocks, the reality is more intricate. The safety of a bond investment is contingent on several factors, including the type of bond, the issuer’s creditworthiness, and the market conditions.

When distinguishing between individual bonds and bond funds, the differences become particularly stark. Holding individual bonds to maturity usually ensures the return of principal, barring a default by the issuer. On the other hand, bond funds, which pool various bonds, are subject to market fluctuations and interest rate changes. As a result, they do not guarantee the preservation of the principal, and their value may decrease if interest rates rise. This was the case in 2022, when the bond market had a bad year along with most other investments.

Moreover, not all bonds are created equal. Corporate bonds, for instance, carry a risk of the issuing company going under. On the contrary, U.S. Treasury bonds, backed by the federal government, are deemed some of the safest in the world. Nonetheless, even government bonds are not immune to market volatility, as evidenced by the significant downturn in bond and stock prices in 2022.

To comprehend the role of bonds in a diversified portfolio, it is essential to consider one’s investment goals and risk tolerance. Bonds can serve different purposes: from providing a steady income stream through interest payments to offering a more conservative balance to an equity-heavy portfolio. However, it’s crucial to recognize that “safe” and “conservative” are not synonymous. While bonds may be more conservative relative to stocks, they are not entirely devoid of risk.

Understanding the complexities of the bond market is key to making informed investment decisions. By appreciating the distinctions between individual bonds and bond funds, recognizing the different levels of risk associated with various issuers, and aligning bond investments with one’s financial objectives, investors can more effectively navigate the terrain of the bond market. It’s a nuanced journey, but with the right knowledge and guidance, bonds can play a vital role in achieving a secure and balanced investment strategy.

Here’s some of what we discuss in this episode:

• Bonds can mean many different things so how do we define it?

• The difference between individual bonds and bond funds.

• How do bonds lose money and why did things get so bad in 2022?