Why invest in bonds?

People purchase bonds for a variety of reasons.You will want to purchase bonds to diversify your investments.Bonds come from several different sources and with these differing sources come different advantages.The basic advantage of a bond is that they are often more a more secure investment than a traditional stock and they have a set interest rate instead of variable rates like stocks.

A bond is a loan that is given to the government or some other entity.The federal government issues bonds and guarantees that they will pay the principal and interest earned in a given period of time.States, cities and corporations can do the same thing.A stock in a company is actual ownership of the company while a bond is making a loan to the company.

Bonds are rated by independent companies on how financially secure the issuer is or how likely the issuer is to pay the bond back.Companies that are close to bankruptcy issue bonds and they are referred to as `junk bonds' because the likelihood of receiving your money back is questionable.A highly rated company or government bond is considered a very secure investment.

The first reason to invest in a bond is for the financial security.A traditional stock can go up or down, but a bond will pay out interest and return the initial investment.This is the same reason why you can use it to provide diversification in your portfolio.Bonds will give steady income when the stock market is on a roller-coaster ride.

You may also be able to receive tax breaks from purchasing bonds.The federal government often does not tax bonds issued by state and local governments.This means that they are often free from tax.This allows the local governments to borrow money at a cheaper rate and the purchaser of the bonds to make a good return because they don't have to pay taxes on them.

However, local governments can go bankrupt, so bonds are not risk free.You must always calculate the risk of the bonds that you are purchasing.No investment is risk free, but highly rated bonds are considered one of the safest ways to invest your money.

Another advantage of a bond is that you can purchase the bond when interest rates are high and then when rates go down, you will still be making a high interest rate on your money.However, some bonds may be `called.'You must check before purchasing a bond whether the issuer can purchase the bond back before the bond matures.If they can, and interest rates drop, the company or entity can call the bond and then sell more bonds at a lower interest rate.

A disadvantage of the bond is that if interest rates rise, you may be getting a low interest rate and cannot sell the bond.Bonds are not considered as liquid as other forms of investment like stocks.Some bonds are traded daily like US Treasury bonds, but others may not trade often or at all.If this is the case, you may have to sell it at a loss in order to get your money out and invest in a higher interest rate bond or stock.

This highlights another disadvantage of the bond and that is timing.You will want to know when you need your money back before you purchase a bond.Many bonds are not very liquid so you will have to time the maturity date of the bond with the date you need your funds back.

In summary, bonds are one of the most secure ways to invest.The give a set interest rate over time and you can get ratings on the bonds based on the financial security of the issuer.However, many bonds are not very liquid and can be difficult to sell so you need to make sure you don't need your funds back until the bond matures.