Are bonds a good investment in 2022? Bonds have long since played a key role in the advised portfolio diversification for those looking to make solid long-term investments. Representing the balance point between safe, but poor returns, from cash and the more volatile, yet higher earning potential of stocks, many have been pushed towards bond investment as a safe, but earning, vehicle. With the staggering economic changes in the wake of the global pandemic, however, are bonds still a tried-and-trusted investment for 2022? We take a closer look.
Part of a Holistic Financial Strategy
Conventionally, we’ve always seen investors encouraged to scale back on equity exposure and instead move money into bonds as they age. Historically, bonds have not been as hard-hit by market downturns as stocks can be, leading to the rule-of-thumb advice to keep your stock allocation to 100- your age in any portfolio, investing the majority of the remainder in strong bonds. Bonds are the ‘shock absorbers’ to stop panic selling of stock portfolios and insulate people against stock market downturns that would take many years to recover from, especially as they reach an age where time is not on their side.
This strategy has already been questioned in recent years, with the figure revised upwards from 100 to 110 and even 120. In short, stock exposure is where the majority of wealth is created, and bonds have mostly been held as a form of security against market fluctuations. As we’ve begun to live longer, and as ‘guarantees’ like company pensions and a cosy retirement fall away, the general advice has swung towards chasing greater growth through equity exposure for as long as possible. Yet the bond remains an important part of any diversified portfolio, never-the-less.
What is a Bond?
Bonds are issued against the debt of entities, most commonly governments or corporate entities. This debt is ‘sliced up’ into small units and sold to investors. They’re senior to stocks in the bankruptcy hierarchy, so will get paid out first in event of an emergency, pay regular interest to investors, and the return of the original investment is guaranteed once the bond expires, meaning you (theoretically) cannot lose your principal. This means that bonds will go down when interest rates go up, and vice-versa. It also makes them very attractive to people who want to earn inflation-beating interest, but cannot afford to take the risk of a loss.
Think of the bond as a micro-loan to the company, where you expect your money back and some interest for its use at the end of a fixed term. On the flip side, a stock is you owning a microscopic part of the company, so you sign up to take profit or loss, whichever occurs, although you can sell at any time.
Government Bonds vs Corporate Bonds
Of course, not all bonds are created equal. Government bonds are issued by the governments of various countries. This means they’re issued directly from the treasury department and carry strong guarantees. There’s a myriad of categories, from inflation-protected bonds to small denomination savings bonds and more, but they all work on the same rules.
Being issued by a government authority means that these are seen as the safest class of bonds around. Even if you’re buying from a different country to your country of residence, the chances of a government of any sort undergoing such strife that it cannot honour its bonds are small. (Yet it is not unheard. Greece (in 2015) and Russia (in 1998) are examples of sovereign debt defaults.)
If you are purchasing US, UK or any other country offering investment grade government bonds, (Three major credit rating agencies are Standard & Poor’s, Fitch, and Moody’s) chance of having a loss on your investments is miniscule.
British government bonds issued by HM Treasury are called ‘gilt-edged securities’ since they are considered as a very safe investment option. UK gilts are listed on the London Stock Exchange. UK government has never defaulted on its debt.
Another tool you need to be aware of that is the credit default swaps(CDS) which are derivative contracts that enable investors to hedge corporate or sovereign credit risks. In layman’s terms, they are insurance contracts. CDS are effective indicators in determining investment strategies in the bond market and even considered as a better measure of sovereign credit risk than credit ratings. So, keep an eye on CDS spreads if you are planning to buy country bonds.
Municipal bonds are merely governmental bonds issued at the level of a municipality, instead of a national government.
Corporate bonds, on the other hand, do carry a little more risk. Companies will often turn to the bond market to finance projects, as it can offer better interest rates and debt financing than a bank or lender. This makes them marginally riskier than a governmental bond, as there’s always the chance of the company going under. Given how bonds are handled in case of a bankruptcy they’re still safer than stocks.
It is unlikely that anything adverse to happen if you are purchasing the bonds of a company with satisfactory financial performance. However it is always advisable to make a research about the company and check corporate credit ratings which is the assessment of creditworthiness (Very similar to the country credit ratings.) and the CDS spreads of the company.
Green Government Bonds
Green savings bonds are a relatively new financial instrument issued by governments and large corporations. Governments issue green government bonds to raise money and finance projects that benefit the environment. Therefore can be viewed as as a form of socially responsible investing that supports environmental sustainability
Some of the most common uses include financing renewable energy infrastructure (such as solar panels and wind turbines), green buildings, and funding research into clean energy technology. In addition, they can also be used to provide funding for social programs aimed at reducing pollution or improving air quality.
Some of the green bonds offer a competitive rate of interest. Investors may also receive tax incentives for investing in green bonds. Green bonds have become increasingly popular since they were first introduced in 2007. Today, there are over 2,000 green bond issuers around the world. Green bonds can be purchased by individual investors through brokerages and other financial institutions.
Are Bonds a Good Investment in 2022?
2020, brought on an economic crisis like no other by affecting the supply chains. We still continue to feel the impact. In many ways, the conventional rules do not apply. So are bonds a good investment right now? The answer, as with many financial products, is that it depends.
Bonds have never been a top choice for young investors. Not from risk, but because they are so safe they usually offer very little return, and most young investors who are buying to hold can afford to let the stock market bumps work for them in the long run. It’s one of the most difficult financial environments of modern times to predict.
In general? Surging of inflation and rising interest rates have greatly impacted the bond market during the 2021 and 2022. And there’s one thing we’ve seen through every other financial crisis to date- the flee from stocks to safer bonds.
While conservative investment in bonds is not for every portfolio, and despite the many unprecedented hits to all financial investments that have made them a less attractive product than usual, bonds still have a critical role to play in portfolio diversification, especially in a year like 2022.
While you should always tailor any financial advice to your specific situation, in general, there’s still plenty of room for high-yield bonds and well-managed bond funds in any investment strategy in 2022.
Are bonds a good investment? That depends on the needs of your portfolio. But we certainly wouldn’t discount them as a possible investment option in 2022.