Weighing the Costs and Benefits of Corporate Bonds

Corporate bonds are an investment tool that a lot of investors tend to lean on for their portfolios. They are offered by a number of different companies and present you with an alternative to the stock market. Here are the costs and benefits of investing in corporate bonds. 

Benefits

  • Relatively safe--When you invest in corporate bonds, you are taking part in a very safe type of investment in general. As a bond holder, you are actually a creditor to the corporation. Therefore, you will receive an interest payment in return for your loan. If the company goes bankrupt, you will stand a chance of getting your money back since you are a creditor. A stockholder, by comparison, would receive no compensation if a company went under. 
  • Rating systems--Another advantage of investing in the corporate bond market is that you have a clearly defined rating system offered by investment experts. For example, Standard & Poor's issues bond ratings on all of the major corporate bonds. If a bond is rated AAA, you know that the company has a stellar credit record and has a very good chance of flourishing in the future. If the company has a rating of B or C, you know that you are getting into some of the lower-tier companies. While those companies are riskier to invest in, you will get a higher rate of return. The rating system allows you to determine exactly what you are getting into before you invest. 
  • Regular interest payments--With a bond, you will receive regular interest payments while you hold the bond. This provides you with a steady stream of income that you can count on for the most part.

Costs

  • Opportunity cost--The biggest drawback of investing in bonds is that your rate of return is capped. You can receive only a certain amount of return no matter how well the company does. It has been proven that over the long term, stocks will outperform bonds. Therefore, when you sink your trading capital into bonds, you are giving up the opportunity to invest in stocks. This could potentially mean missing out on quite a bit of money in the long term. 
  • Risk of default--When a company files for bankruptcy, there is some chance that you will lose your initial investment as well as the interest payments that you were counting on. As a creditor, you do have a claim on the assets of the company. However, if the company was over-leveraged, there may not be enough assets to go around. If there are other larger creditors in front of you, you might receive very little or nothing back from your initial investment. In other words, bonds are not actually a sure thing.
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