Why Bonds Should Be Part of Your Portfolio
A Guide to Low-Risk Investing
Central banks worldwide hiked bank rates multiple times in 2022 amid concerns surrounding an impending economic slowdown. Additionally, the cost of living everywhere has been continuously rising, while unemployment rates have been worryingly high since the start of the covid-19 pandemic. With most financial firms cutting their growth forecasts, you must prepare for an economic downturn in the coming months.
It is essential to point out that continuing to invest in profit-making assets despite the economic risks involved is essential. For that, you need an investment plan. For most of us, the goal is to invest smart and retire early. Investing in the bond market should be the obvious choice. It is the safest investment if you want to protect your wealth or earn a decent return without taking too much risk. There are two ways to profit through the bond market. One is to hold the bond till its maturity and profit from the interest earned. The other is through the secondary market, where existing bonds are bought and sold at a discount or a premium to their original value. You make money in capital gains.
The risk in the bond market is primarily of two types. These include credit risk and market risk. When you buy government bonds, there is zero risk. You can never lose money in government bonds if you hold them to maturity. The government guarantees the interest on these bonds. The performance in the secondary market does not impact the coupon rate promised. As a result, bonds provide a predictable income stream. For example, if you invest in government securities, you are sure to receive fixed coupon payments twice a year, despite price changes. A coupon payment is fixed on the face value of the bond. For instance, if you invest in a bond worth 1,000 rupees with a coupon rate of 7%, you will get 70 rupees per year. This amount is usually paid every six months, so you get two payments of 35 rupees each.
The element of risk appears only when you trade in the secondary bond market. Your best weapon to deal with that risk is to understand the yield curve. Interest rates generally trend down in a high-growth economy. However, high
For example, the bond price will decrease when the interest rate increases. At the same time, the reinvested yield of coupons for the bond will increase, and vice versa. Therefore, an effective strategy requires that these two opposite effects cancel each other out, guaranteeing that the asset's future value will not be affected by the fluctuations in the market. Moreover, bonds should appeal to those who trade in the Indian market. There is great potential in India's debt market, which is valued at around $2.1 trillion. India's bond market even trumps its stock market. About $1.6 trillion is made up of government bonds, with a good chunk comprised of issuances by various Indian states (State Development Loans or SDLs) and other agencies. Whether your goal as an investor is to make more money without increasing your initial investment or to protect your investment from any potential market risks, having a diversified portfolio is crucial. Balancing your portfolio with a good mix can protect your investment in the long run. Using smart bond investing strategies like the immunization strategy can add the necessary edge.
Bonds are helpful for those with surplus funds looking to generate a regular income. You can create a 'tap of money' flowing into their account every six months. Many high-net-worth individuals and companies with surplus cash rely on that plan. The idea is to never run out of cash. At the same time, it ensures wealth protection.
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