Bonds will be a big loser if invest for long term
This post will touch on why investing in bonds will be detrimental to financial health if your investment horizon is 10 years or more. This is especially true for those in the below 40 years old age groups.
To recap, bonds are simply IOUs issued by governments and major corporations listed on stock exchanges. They are loans to you, as an investor, make to them in exchange for getting your principal back, along with regular and periodic interests payments every quarter or biannually.
Coupon of bond = interest of principal paid each year. Image Credits: lilivanili
For instance, a bond with a 10% coupon rate and principal sum of $1000 will pays you an annual amount of $100.
Here are a few reasons why investing in bonds for long term is a sure lose event, second only to savings account. The enemy is inflation. In other words, the bond income alone decreases in value by more than 50% as in purchasing power assuming that it is redeemed at maturity 20 years later, and assuming inflation is 4% on average each year.
1. Coupon payments are fixed in absolute dollars amount throughout the whole life of the bonds.
This by definition already means that it will not keep up with inflation even if the bond issuer did not default.
2. The principal sum used to purchase the bond, for example, $1000, will also be the sum used to purchase back the bond by the issuer.
The $1000 after more than 20 years never appreciates in value. Assuming that inflation averages 4% per year, the $1000 is worth only $460.40 20 year later.
3. Bond prices are really not stable compared to stock prices.
Bond prices are affected mainly by interest rate, among many other factors, which resulted in volatility in bond prices. As a result, bond prices are nearly as volatile as stocks.
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