Let's continue with the following important asset class and learn:
- What are bonds?
- Characteristics of bonds
- How do bonds differ from stocks, and why do investors choose bonds?
What are bonds?
A bond is a debt security under which the issuer undertakes to pay interest and principal at maturity.
The issuer can be a company, municipality, or state.
Unlike stocks, when buying a bond, an investor does not become an owner but only a creditor.
So why invest in bonds?
- Interest paid by the issuer
- Capital gains, in case of an increase in the value of the bond and a decrease of interest.
Last but not least, bonds may be categorized as relatively low volatile.
Bond price and interest rate
Remember, the key feature of a bond is the dependence of the bond's value on the interest rate.
When the interest rate falls, the value of the bond rises. And vice versa. As interest rates rise, bond prices fall.
Comparison with stocks
The main difference between bonds and stocks lies in the degree of risk. Historically, stocks have shown greater returns but, as we already know, more significant risk.
Therefore, in the short and medium term, bonds can be an excellent alternative to stocks for those who want to avoid additional risks according to their investment goal. Or, within the portfolio's structure, one wants to have a relatively risk-free part. We will talk about portfolios in more detail later.
