What are the benefits of bond investing?
Bonds and stocks are the primary investment assets in the global investment market. Uninformed investors may be surprised, but despite the overall lower long-term return, bonds are the most popular investment. As of 2021, the total market capitalization of domestic companies listed on stock exchanges worldwide exceeded the total market capitalization of the bond market (total debt outstanding). The gap widened in 2022 as stock prices fell. As a result, bonds have become likely the most popular financial instrument for investment in the world.
Capitalization of the global equity and bond markets at the end of 2022 (in USD trillion)
Source: Securities Industry and Financial Markets Association (SIFMA) and Statista
If you want to invest in the stock market, keep the investing rules in mind. One of them is that, when creating an investment portfolio, it is critical to maintain the proper balance of profitability and reliability. During periods of rapid market growth (such as 2020-2021), it is preferable to invest in riskier assets such as equities and cryptocurrencies. Instead, when financial markets fall (as happened in 2022), it is better to invest in more stable assets such as bonds, real estate, and gold. Given the rather pessimistic forecasts for global economic growth in 2023, it may be worthwhile to keep a larger share of your portfolio in stable financial instruments.
Reduced volatility and increased transparency
Bonds are also a good investment for those who dislike sudden market movements and changes in asset values, as well as those who count on stability and a predictable income with a low level of risk. Bonds are generally less volatile than stocks. Bond values can fluctuate depending on current interest and inflation rates, but they are typically more stable than stocks.
As inflation in Switzerland reached 2.8% in December 2022 (down from 3.5% in August 2022), the Swiss National Bank raised its policy rate by 50 bps to 1% at its December meeting. In response to this rollercoaster, the SMI index fell 6.51% from the end of January 2022 to the end of January 2023. At the same time, Switzerland’s 3-year bond yields rose from -0,335% to 1.055%.
Another advantage of bonds over stocks is that in the event of bankruptcy, you have a better chance of recovering at least a portion of your invested funds as a bond investor. Given the impeding recession, this factor is critical to consider when considering portfolio allocation in 2023.
While stocks are not risk-rated, bonds are typically rated by agencies such as Standard & Poor's or Moody's. This allows investors to understand how much risk they are taking on when purchasing a bond, with riskier bonds offering higher coupon rates.
Moody’s, S&P, and Fitch credit ratings scale for corporate bonds
Source: Wolf Street
The expected return of a bond, like any other investment, must be balanced against its risk: the riskier the issuer, the higher the yield investors should demand. Junk bonds (high-yield bonds), as a result, pay higher interest rates but are also more likely to default. Governments pay very low-interest rates but often have almost no risk.
Additionally, experienced investors suggest structuring your investment portfolio depending on your age. Bonds should be a larger part of your portfolio as you get older. And vice versa: the younger you are, the more it makes sense to take risks and invest in stocks. According to a popular belief, the percentage of stocks in your portfolio should be equal to 100 minus your age. So, if you're 30, you should have 70% stocks and 30% bonds in your portfolio. If you're 60, you should have 40% stocks and 60% bonds.
Investors will receive the same predetermined interest rate each period (usually twice or once a year) that they own bonds. However, the yields depend on the price at which the bonds were purchased and the term until maturity. In that case, now is a good time to buy bonds because prices are lower than they have been in recent years. This means that the yield on bonds purchased now will be higher than the yields on bonds purchased from 2012 to the first half of 2022.
Bonds are more profitable than bank deposits and cash
Bonds’ main purpose is to cover the level of inflation with their yield rate. That is, their owners may not lose the value of their resources over time. In 2022, the situation changed, with inflation rapidly rising while bond yields also rose. The 10-year Swiss Confederation bond yields increased from -1.0% in August 2019 to 1,263% at the beginning of January 2023.
The Switzerland 10-Years Government Bond Yield
In times of high market volatility and uncertainty, the liquidity of your portfolio may become its most important feature. Generally, the bond market is considered to be liquid. Bond liquidity, for example, is superior to that of real estate. At the same time, keep in mind that different types of bonds have varying levels of liquidity. Government bonds are more liquid than corporate bonds. Liquidity also depends on market conditions and the size of the bond lot (which can be worth CHF 10’000, CHF 50’000, CHF 100’000, or even more). The larger lot you purchased, the less liquid it will be.