Bonds are a common investment avenue for people looking to make money. Reports say the worldwide bond market accounts for over $100 trillion! Bonds are so popular because they help individuals diversify their portfolios, get excellent returns, and provide several other benefits. One can also choose from several bond options based on their preferences. But before investing, one should understand the fundamentals and keep a few important things in mind.

What are bonds?
When a person invests in a bond, they lend a certain amount to the issuer. The bond issuer is usually an organization, such as a government body, corporation, or municipality. The entity issuing the bond commits to pay the investor interest on the loan at a predetermined rate and returns the principal amount when the bond matures.

Key considerations when investing in bonds
While bonds are great investment options, they only provide a good return if one researches well. Those looking to buy bonds directly must consider a few important things, such as their type, maturity period, risk, and likelihood of appreciation.

Type of bond
Bonds are classified into different types based on who issues them. For example, corporations issue corporate bonds, local and state governments issue municipal bonds, and the treasury or federal government agencies issue government bonds . Studying each type is critical because they have different features and risk and return profiles.

Maturity
The maturity refers to the lock-in period of the money. Before one invests in a bond, they should check when they will get their money (principal) back. Bonds have varying maturities, ranging from weeks to decades. Most consumers will benefit from a mix of short and intermediate-term bonds.

Bond rating
A bond’s rating indicates its creditworthiness or how likely the borrower will repay one’s money. One must investigate this aspect when investing in bonds. Choosing a bond with a lower creditworthiness is a bad idea because the risk of losing money is high. To assess a bond’s creditworthiness, one can check its credit rating. AAA has the highest rating based on the S&P scale. A bond with a C rating or lower is classified as low-quality or junk and is at the highest risk of default. Bonds rated D have already defaulted in one or more areas.

Capital appreciation
Bond prices can rise for various reasons, like interest rate changes and an improvement in the issuer’s creditworthiness. But if a bond is held to maturity, any price increases throughout its life go unrealized. Instead, its price returns to par as it approaches maturity and principal repayment. So, investors can profit from price appreciation ( known as capital appreciation) by selling bonds after their prices have risen and before maturity. Capital appreciation on bonds boosts one’s return and has become one of the most popular bond strategies in the last four decades.

Risk tolerance
Individuals should consider their risk tolerance before investing in any avenue, including bonds. Bonds with a lower credit rating often pay higher yields to compensate for higher risk levels. Still, buying them may not be a good idea if one is struggling financially and cannot afford to lose money. Focusing on high-quality bonds is advisable in this case. It helps diversify one’s portfolio and lower the chances of a loss, especially during economic uncertainty when equities are most vulnerable to downturns.

Interest rate
While individuals receive the principal amount back only after maturity, they earn interest periodically. The frequency of interest payments differs depending on several factors. One must remember that the interest rate can change over the bond’s tenure. As interest rates rise, bonds lose value. Since it is difficult to foresee how interest rates will move, one must invest carefully.

Tax advantages
The money one earns from bond investments may or may not be taxable. Municipal bonds are usually tax-free, making them a popular choice. Before investing in a bond or bond fund, one should also decide whether to keep it in a taxable brokerage or a tax-sheltered account like an IRA or 401(k). Bonds that generate taxable income are typically held in tax-sheltered accounts, whereas those that provide tax advantages can be held in taxable accounts.

Investment goals
Before investing in bonds, one should set goals and financial objectives and not change them because of short-term market volatility. Many people invest in bonds because they serve as a hedge against an economic slowdown or deflation. During inflation, a bond’s fixed income becomes less appealing since it buys fewer goods and services. Inflation is typically associated with higher economic growth, which boosts demand for goods and services. Conversely, slower economic development reduces inflation, making bond income more appealing.

Unlike stocks, which require the firm to grow for the investment to be profitable, bonds can be profitable even if the company (or government) survives. Another reason bonds are popular is they diversify one’s portfolio and balance the investments in stocks and other asset classes. But that does not mean they do not have drawbacks. That’s why one should consult a financial advisor before investing in bonds. The expert can suggest specific sensible investing tactics to reduce the dangers of this investment option.