There are many ways money can be invested today. Corporate bonds are a way for companies to raise money from investors in order to finance business activities. In return for the investment, the company promises the investors to pay interest at regular intervals so that a profitable return can be earned by the maturity date of the corporate bond. It’s considered a safer way to invest into a company compared to shares.
There are a number of pros and cons of corporate bonds to be considered before making an investment. Here are some of the key points to think about before putting your cash out there.
What Are the Pros of Corporate Bonds?
1. Bond holders generally rank higher as a creditor than shareholders.
If the company fails for some reason after a corporate bond investment has been made, then the bond holders typically rank higher than shareholders do when debts do get paid. This higher priority gives you a better chance of recovering most, if not all, of your investment even if the company goes under.
2. Bond coupon payments are structured.
You know for certain about the interest payments you’ll be receiving when you invest into a corporate bond. The coupon payments are structured much like any other loan a consumer might take out to purchase something. Dividend payments and other disbursements are at the discretion of the company. This means investors have more certainty about getting a return on their investment.
3. Pricing of corporate bonds is typically stable.
You won’t have the same price fluctuations with corporate bonds as you will with shares or other investment opportunities. This means you can know with some certainty what the face value of the bond will be and have some predictability on what your income stream will be over the life of the investment.
4. Corporate bonds typically have a better return than other bonds.
There is a little more risk associated with corporate bonds compared to government bonds or other types of bonds, but that also means there’s the chance for a greater return. If you purchase bonds for a reputable company, then even if interest rates fall, you can potentially sell your bonds for a profit on a secondary market if you need to get some cash.
5. Some corporate bonds can convert into stock.
Although this adds to the risk assumed by the investor, it also means that the investment can be sold at the current market value. This move could bring in more profits under the right circumstances.
What Are the Cons of Corporate Bonds?
1. It may not diversify your portfolio.
If you purchase corporate bonds from a company where you’re also a shareholder, then you aren’t creating diversification in your portfolio. If the company goes under for some reason, you could be left with some big losses and little chance at a recovery.
2. Corporate bonds do not generally provide capital growth.
This type of investment is not designed to increase in value over the life of the corporate bond. You will receive timely interest payments assuming the company does not default on them and receive your initial investment back in full plus the interest at the maturity date, but that is it.
3. Selling corporate bonds can be somewhat tricky.
If you decide that you need to get out of a corporate bond before it matures, then selling it on a secondary market can be a little difficult. There’s a good chance that you won’t receive the full face value of the bond. If interest rates have gone up since you made the investment, the loss you might end up taking to get cash could be quite large.
4. Secondary markets typically have fewer buyers.
Sometimes you won’t even be able to find buyers who are interested in a corporate bond as an investment on the secondary market. That can make it hard on an investor who needs to have some cash right now.
5. Having interest rates rise can make corporate bonds less profitable.
The value of a corporate bond will also be affected by the stability of the company which is backing the bond in the first place. Both situations can affect the profitability of the investment on an individual level.
The pros and cons of corporate bonds must be weighed carefully before making an investment. Only you can know, through your own due diligence, if any specific corporate bond is right for your portfolio.