Bonds

Technically speaking, a bond is a loan and you are the lender. Usually the borrower is the U.S./European government, a state, a local municipality or a big company like General Motors. All of these entities need money to operate –to fund the federal deficit, for instance, or to build roads and finance factories –so they borrow capital from the public by issuing bonds.

When a bond is issued, the price you pay is known as its “face value.” Once you buy it, the issuer promises to pay you back on a particular day –the “maturity date” — at a predetermined rate of interest –the “coupon.” Say, for instance, you buy a bond with a $1,000 face value, a 5% coupon and a 10-year maturity. You would collect interest payments totaling $50 in each of those 10 years. When the decade was up, you’d get back your $1,000 and walk away.

Treasury Bonds

Politicians like raising money by selling bonds, as opposed to raising taxes, because voters hate taxes. Of course, when the government issues these Treasury bonds, it promises to repay the bond buyers over time. The more bonds the government issues, the greater its debt. The interest payments on that debt are an enormous burden, currently totaling more than $450 billion a year.

There are many kinds of Treasury bonds — from EE Bonds to I Bonds to TIPS — and each has unique characteristics. All of them, though, are backed by the “full faith and credit” of the federal government. Despite its huge debt, the United States of America is not going bankrupt any time soon, and for that reason, Treasury bonds have traditionally been referred to as “risk-free. That does not mean that the prices of Treasury bonds don’t fluctuate.

When bond experts speak of treasury bonds as having no risk, or almost no risk, what they mean is that the bonds have no credit risk. But Treasury bonds are very much subject to the other kinds of risk that beset other bonds: interest rates, inflation, and reinvestment.

Corporate Bonds

Bonds issued by for-profit companies are riskier than government bonds but tend to compensate for that added risk by paying higher interest rates. For the past few decades, corporate bonds in the aggregate have tended to pay about a percentage point higher than Treasury bonds of similar maturity. Since 2008, this spread has broadened to about a
percentage point and a half.

Corporate bonds tend to get called a lot. That means that the corporation changes its incorporated mind about wanting your money and suddenly throws it back at you, canceling the bond. Bond calls tend to happen when rates have fallen.
That adds a heavy dose of unpredictability to what should be a predictable investment.

Bonds are the classic “conservative” investment-low or no risk, but only modest returns.

When you buy a bond, in effect you are lending money to a company or a government, which that company or government is then obligated to pay back to you, with interest, after a set period of time. (You can also buy and sell bonds though. So it’s not like if you buy a twenty year bond, you can never get any money for it until twenty years have passed. You could sell someone else the bond before then, basically selling them the right that you now hold to collect that money after twenty years.)

Let’s look at some of the pros and cons of investing in government bonds specifically:

Pros of Investing In Bonds

  • Predictable interest rate. Bonds don’t have the volatility of, say, stocks. You are paid a certain predetermined interest rate over the life of the bond.
  • Lack of commissions and trading fees. Often bonds can be purchased directly from the issuing authority. In the case of government bonds, you can buy bonds directly from the federal, state, or local government.
  • Tax advantages. The profit on government bonds, especially municipal bonds, is often tax free.
  • Safety. The main benefit most investors value about government bonds is their safety. Unless the government goes under entirely (in which case you’ll have a lot more to worry about than whether your investment paid X percent or Y percent), you’re not going to lose your money.
  • Patriotism. Some people believe you are supporting your country by loaning money to the government, though this certainly is not a universal sentiment. Historically, attitudes can change about such things, as attitudes about government change.

Cons of Investing In Bonds

  • Lower profit – The flip side of not having to worry so much about volatility or default is that the rate of return on bonds is quite modest. Over the long run, just buying a wide variety of stocks invariably does better, albeit with a great deal more fluctuation along the way.
  • The risk of default can be considered a con of bonds, as if the issuing entity goes under, it takes your money with it, but as noted above, this is far less of a risk with government bonds than with certain other bonds, like those issued by a company that may be shakier financially than it looks from the outside.
  • Inflation – with a global currency war in action, the value of your money once your bond matures may, in real terms, be worth less than when you took out your bond due to inflation.
  • Investors who buy bonds

Investors who buy bonds

  • They provide a predictable income stream. Typically, bonds pay interest twice a year.
  • If the bonds are held to maturity, bondholders get back the entire principal, so bonds are a way to preserve capital while investing.
  • Bonds can help offset exposure to more volatile stock holdings.

Property

Buy-To-Let

  • Buy-To-Let refers to the purchase of a property specifically to let out. A buy to let mortgage is a mortgage specifically designed for this purpose.
  • Renovating – If you’re a budding developer, the most common strategy is to buy a property cheap, renovate it and sell it for profit.

Risks

There are several risks when you buy property directly, whether for yourself or as a buy -to-let investment.

  • You can’t get your money out quickly – unlike shares or bonds, it takes a long time to sell property. And although you can sell it a bit at a time, it’s not really practical.
  • It’s a big commitment – when you buy a property, you’re putting a lot of eggs in a single basket.
  • There are buying and selling costs – with estate agent and surveyor fees, stamp duty, land tax, solicitors and conveyancing fees to consider.
  • There are buying and selling costs – with estate agent and surveyor fees, stamp duty, land tax, solicitors and conveyancing fees to consider.

If you use a mortgage or a loan to buy property, there are additional risks:

  • There’s no guarantee you’ll earn enough rent to cover loan repayments.
  • The cost of the mortgage might rise.
  • If you don’t keep up with repayments, the bank or building society can take back the property.