Investors generally look for safe way to preserve their capital but at the same they plan for a good returns from their investments. If you look at both i.e. securing capital and earning decent returns then “Investing in bonds” would be given highest priority by investors.
Investing in bonds is very simple, but before that doing a proper research is recommended, as all the bonds are not same. As an Investor it is your responsibility to know about ” short-term and long-term bonds”, especially in long run how they are going to perform.
In this blog post we are dealing with “difference between short-term and long-term bonds” and will cover topics like What are benefits of investing in short term or long term bonds and more. Top investors choose “bonds” as one of the instrument in balancing their portfolio.
Before diving into advanced topics like “how different bonds work?” and which one is better with your financial goals , lets know more about basics .
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What Are Bonds and How Do They Work?
Bonds are financial instruments [ to be more precise they are debt instruments] , generally issued by governments or municipalities to raise capital. Purchasing bonds is not similar to purchasing shares in the stock market. If you are purchasing shares, it is like you are buying a part of the company. But in case of bonds, you’re not buying a stake in the company. Instead you are lending money to the bond issuer, in exchange they will pay you interest on regular basis for predefined period. Once the bond reaches its maturity date, issuer will return all the principal amount back into your account.
Getting Regular and fixed income make “bonds” one of the best way to invest in. Not only for investing but also to diversify your portfolio, investors purchase bonds from various sources. Undeniably one of the best instrument for investors who are looking for better returns by safeguarding their capital.
Understanding about Bond Maturity:
Generally Bonds are classified based on their maturity date [ period between the bond’s issuance date and the date it is repaid]. If the maturity date of a bond is between 1 to 3 years, they are called as Short-term bonds. In some cases maturity period is even more shorter like 90 Days. Next in our list is “Long-term bonds” and the name itself clearly explains the bond maturity time is very long. In general if a bond’s maturity period is over 10 years or more, then they are called as long term bonds.
The maturity period plays a major role in determining the bond’s yield, risk level, and price sensitivity to interest rate changes.
Long Term Bonds :
The long-term bond market is extremely dependent on changes in interest rates. As rates rise, bonds that have lower interest rates are less appealing which results in a decrease in the value of their market. When rates decrease longer-term bonds are more likely to rise in value.
More the maturity period more is the risk in terms of fluctuation. The prices of long-term bonds tend to fluctuate more rapidly in comparison to short-term bonds.
To mitigate the extra risk and a longer-term commitment, issuers provide higher yields for long-term bonds. For example, a 30 year Treasury bond typically offers more than five-year notes, provided that all other variables are equally. This is referred to as the positive yield curve.
These bonds are typically preferred by investors who want to earn long-term income such as retirees and institutions like pension funds.
Short term bonds :
Short-term bond are debt securities which mature in a shorter period of time, typically within 1 to 3 years. As we have earlier mentioned there are bonds with maturity period of 90 Days like Treasury bills. These very short term bonds are considered as cash equivalents or ultra-short-term bonds and are widely used to manage cash or park funds for short periods of time.
Since they mature fast, they experience lower risk of fluctuations in interest rates. If interest rates increase investors can invest at higher yields rather quickly so that potential losses are minimized.
But this security comes at a price i.e. short-term bonds have lower interest rates than long-term bonds.
Short-term bonds are a favorite among investors who value the liquidity of their investments and also capital preservation. When a short-term bond is due to mature it will return the original purchase together with the interest accrued. By holding the bond until expiration, you avoid the possibility of price fluctuations completely.
Generally “Short term bonds” are preferred for
- Emergency Funds
- Saving to meet short-term goals (within one to two years)
- Reducing portfolio volatility
Conclusion :
Hope the info we have covered on “Short term and Long term bonds” is useful for you guys. In real life, many investors make use of both types of “Bonds” for diversifying their portfolio. Balancing your portfolio with both types of bonds reduces the risk and it act as cushion in bad market conditions.
