Bond Investing
Investing in Bonds
From an investor’s perspective, stocks offer a higher potential return if profits rise, but bonds are generally a safer investment. Stock dividends are paid out of company profits, while bond interest payments are made even if the company is losing money. If a corporation goes bankrupt, bondholders must be paid before stockholders. Nonetheless, risks are associated with investing in bonds. Because most bonds offer a fixed rate of return, a bond with a low coupon rate will be less valuable if interest rates rise to the point that the investor’s money could be more profitably invested elsewhere. If the inflation rate rises in relation to the coupon rate, the value of the investor’s return will be reduced.
The value of bonds also will vary due to changes in the default risk, or credit rating, of bond issuers. If the issuer of the bond is unable to make timely principal and interest payments, the issuer is said to be in default. Bonds issued by the U.S. government and by most federally related institutions are considered free of default risk. For other issuers, the risk of default is gauged by credit ratings assigned by four nationally recognized rating companies: Moody’s Investor’s Service, Standard and Poor’s Corporation, Duff & Phelps Credit Rating Company, and Fitch Investors Service. Bonds that these rating companies place in the highest categories are known as investment-grade bonds. Bonds that are not assigned an investment grade rating are called junk bonds. These bonds have a higher degree of credit risk but also offer a higher potential yield. (1)