Investing in bonds often gets a bad rap. Common misconceptions about bonds indicate that they’re boring, low-yield and ineffective for building long-term wealth.
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Yet in reality, putting your money in a fixed-income investment can add stability to your portfolio and offer the ability to earn income. Here are some common misunderstandings about bonds you should be aware of.
Myth 1: Bonds Only Offer Low Returns
Many investors believe bond returns lag far behind stocks. While equities carry a higher upside, bonds still provide meaningful income.
Today’s 10-year US Treasury Notes pays 4%, according to TreasuryDirect.gov. According to the St. Louis Federal Reserve, high-quality corporate bonds yield an average of 5.10%.
While you may not get the double-digit returns you’ll find with stocks, bonds offer much more reliable returns that can still beat inflation. Bonds also offer stable cash flow through regular interest payments. This makes them a good option if you want income from fixed payments. Plus, reinvesting interest can accelerate your overall return on investment.
Myth 2: Rising Interest Rates Mean Falling Bond Prices
This common myth often keeps investors from bonds during Federal Reserve rate hike cycles. However, higher rates predominantly impact the prices of existing bonds versus newly issued ones carrying higher coupons, according to Fidelity. New bonds provide the same relative return even as rates go up.
If you adopt a laddered bond strategy with varied durations and staggered maturities, your interest payments can get reinvested into higher yields. Plus, once your bond matures, you’ll receive face value back and can reinvest the money at improved rates. So, rising rates don’t undermine bond portfolio performance over longer periods.
Myth 3: You Can’t Lose Money in a Bond
While generally less volatile than individual stocks (and even mutual funds), bonds carry some risk.
With individual bonds, you could lose money if the issuer defaults. This is less of a risk with Treasury bonds, which the U.S. government backs.
Bond funds also fluctuate in price based on interest rate changes and economic conditions. So, while high-quality bonds provide relative stability, they are not risk-free and do not guarantee no losses.
Bottom Line
If you’re looking for stability — or some diversity in your portfolio — consider bonds. They can help you lower overall risk in your portfolio and earn steady cash flow.
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Make sure you research beforehand to know which bonds work for your situation and time horizon.
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This article originally appeared on GOBankingRates.com: 3 Myths About Investing in Bonds
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