Should You Invest In Short-Term Bonds? 7 Things To Know
With rampant inflation, you want to ensure that your savings are growing to keep up with rising costs. You want to invest in the stock market but may hesitate due to the fluctuations of the economy.
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As a result, perhaps you’re thinking about adding short-term bonds to your portfolio since these fixed-income securities are less risky and less sensitive to interest rate hikes.
Should you invest in short-term bonds? Here are seven things to know before adding them to your portfolio.
There’s a Lower Risk Associated With Short-Term Bonds
As the name implies, these investment vehicles have a shorter time frame, usually one to three years. This means your funds aren’t tied up for as long as they would be with long-term bonds, and they aren’t experiencing the volatility of the stock market.
If you’ve been paying attention to the stock market, you’ve likely noticed how volatile it can be. If you need your money in the near future, you don’t want to stress about market swings impacting your bottom line.
“Short-term bonds typically have a lower risk profile compared to stocks or long-term bonds,” said Michael Collins, chartered financial analyst and CEO of WinCap Financial. “By adding bonds to your portfolio, you can reduce overall portfolio risk and potentially improve returns.”
While many investments are sensitive to rate hikes, you don’t have to stress as much with short-term bonds, allowing you to focus on other aspects of life.
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They Offer a Steady Income Stream
“Short-term bonds usually offer regular interest payments, providing investors with a steady income stream,” Collins said.
This can be beneficial for those looking for a stable and predictable source of income. With a fixed-income security, you know what kind of returns you can expect.
If you have a short-term investment horizon or have retired, you’ll want safe investments in your portfolio. This steady income will allow you to plan accordingly, which is helpful if you’re looking for stability in your financial life.
Short-Term Bonds Are Ideal If You Have Financial Commitments Coming Up
Many experts have pointed out the importance of including less riskier investments in your portfolio if you have short-term financial goals. For example, if you know that you’re going to need to access your money in a few years to pay for your wedding, you want to assume less risk. If you have any major financial commitments coming up, you’ll want easy access to your money so you don’t have to worry about taking on debt.
“Short-term bonds can be suitable if you need to consider your financial situation and what goals you want to reach,” said Erik Severinghaus, founder and CEO of Bloomfilter. “These are good for people who cannot commit their money for a long time or may require fast access because they have future costs or important life situations coming up.”
They Offer Diversification
When setting up your investment portfolio, you’ll want safer investments to offer diversity so you’re not overexposed in one sector. Diversification is crucial because you don’t want to see your life savings disappear due to an unexpected financial disaster.
Short-term bonds are one way to provide diversification to your portfolio, Collins said.
They Offer Flexibility
Since your short-term bonds will mature in one to three years, you’ll have quicker access to your funds if another investment opportunity arises.
“Short-term bonds have a shorter maturity period, which means that your money is not tied up for a long time,” Collins said. “This can give you the flexibility to reinvest your money in other investment opportunities that may arise.”
You Could Earn a Lower Yield With Short-Term Bonds
One setback of investing in short-term bonds is that they typically offer lower returns than the stock market or long-term bonds. If you’re looking for higher returns and can handle some risk, you may want to limit your exposure to short-term bonds.
“One of the primary risks is lower yield potential compared to long-term bonds or other higher-risk investments like stocks,” said Cliff Ambrose, founder and wealth manager at Apex Wealth. “Additionally, inflation can erode the purchasing power of the returns from short-term bonds, particularly if inflation rates exceed the yield of the bond.”
Better investments are available depending on your risk tolerance profile. If you want to see significant growth, you can invest in the stock market or real estate.
“For those seeking higher returns and who are comfortable with greater risks, more aggressive investment options might be more appropriate,” Ambrose said.
There’s a Credit Risk Involved
“There’s also the credit risk associated with the issuer defaulting on payments,” Ambrose said, “although this risk is generally lower with government bonds compared to corporate bonds.”
Closing Thoughts
It’s essential that you review the advantages and risks associated with every investment option and how to decide whether it makes sense for your situation to allocate some funds to short-term bonds.
“When you plan your investment approach, it is important to balance the advantages and dangers,” Severinghaus said. “Reflect on the role that short-term bonds could play in your wider economic strategy. If chosen correctly, they might assist you in moving smoothly through monetary turbulence and maintain a stable direction towards your investing targets.”
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