Is a Guaranteed Bond a Risk-Free Investment?

A guaranteed bond is a type of bond that has a guarantee of payment associated with it. With a guaranteed bond, another organization is in charge of guaranteeing the payments if the issuing company goes out of business. Here are a few things to consider about guaranteed bonds and whether they are a risk-free investment.

Guaranteed Bonds

When you invest in a guaranteed bond, you are essentially loaning money to a company. Therefore, you are investing in the company's ability to succeed. However, sometimes, companies will go out of business for one reason or another. When this happens with a traditional bond, you are potentially going to lose your initial investment. You will also lose the regular interest payments that you have been receiving. With a guaranteed bond, this is not the case. If the company that you invested in goes out of business, another company or organization is going to step in and make the principal and interest payments for them. For many investors, this is a very attractive investment because it lowers the potential risk involved. Even though it might seem as if there is no risk associated with this type of investment, there are a few types of risk that you may want to be aware of.

Some guaranteed bonds are actually guaranteed by a federal government. The most common example of this is in Canada. If a company that issues a guaranteed bond goes out of business, the Canadian government is going to start making the payments for them.

Default Risk

The first type of risk that you need to be aware of is the risk of default. If the first company goes out of business, you are going to be relying on another company or organization to make the payments for them. In many cases, this works without any issues. However, in some cases, you may not continue to receive your payments. You are basically betting on the company that is guaranteeing the bond payments to stay in business as well. In some cases, that company might go out of business also. At that point, there will be no one to guarantee your bond payments, and you will lose your investment. The strength of this investment plan is only as good as the company that is making the guarantee on the bond payments. 

Inflation

Another risk that you are taking with this type of investment is that you may not be able to beat inflation. In many cases, these types of bonds carry very low interest rates. When interest rates are this low, most of your returns could be eaten up by inflation. Any time that you get a guarantee on something, the interest rate is going to go down. 

One of the first rules of investment is that you have to take on additional risk in order to get additional gains. If you are taking on a very low amount of risk, there is a very low amount of interest that you can earn. 

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