Bonds are a very popular investment, but before you buy any, let me tell you what I share with my clients about them.
Think of a bond as a loan between you and a company or government. Assuming all goes normally, here’s how it looks:
1. You lend them a sum of money
2. They pay you interest periodically until “maturity.”
3. They return the principal of the loan on a specified date
Investors looking for steady current income (perhaps to supplement a pension) and wanting to diversify their portfolios often purchase “fixed income” securities (as bonds are often called). Owning bonds may give the investor a sense of security because the issuer guarantees to pay back the principal of the bond. However, bear in mind that the “guarantee” is only as solid as the guarantor, so if the issuer defaults you could lose money.
Government bonds are generally considered to be safe investments, since the government has the ability to raise taxes and print money in order to generate enough revenue to repay bondholders. But nothing is guaranteed. Even governments occasionally default on bond payments. Indeed, in August 2015 Puerto Rico defaulted on some of its bond payments. Nonetheless, government bonds are still considered relativelysecure, with American treasury bonds at the top of the list.
What bond is right for you?
There are many types of bonds and bond funds, each meeting different investor needs. While U.S. Treasury bonds and some municipal bonds may be tax free in certain circumstances, they are still subject to Israeli taxes.
Corporate bonds can provide dependable income, as well as a somewhat liquid market if you want to sell a bond you own. A more risky sector is high-yield, or “junk bonds.” While these bonds can provide a higher potential return, they also carry a higher risk of default. In addition to buying a specific bond, there are bond funds that mitigate the risk of owning specifics by creating a broadly diversified portfolio. These funds, though, have their own risks, so be sure to read the prospectus before investing.
