Ask A Fool: Is Bond Investing Safer Than Buying Stocks?

By Dan Caplinger Markets Fool.com

Q: I'm nervous about investing in the stock market. Is bond investing safer than buying stocks?

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A: Many investors use a balanced approach to investing, dividing up their investment portfolios between stocks and bonds in order to manage risk. Bonds have a reputation for being safer than stocks, but both bonds and stocks have their own kinds of risk.

The primary benefit of a bond is that the income it pays is predictable. Most bonds make fixed interest payments on a regular basis and then pay back your principal when they mature. There's a risk that the bond issuer won't be able to repay the bond when it matures, but you can manage that risk by choosing more creditworthy issuers.

However, just because payments are predictable doesn't mean that you can't lose money with bonds. Bond prices are sensitive to changes in interest rates, and they tend to lose value when rates rise, as they have recently. That doesn't necessarily matter if you own an individual bond and hold it until it matures. But many bond investors use bond funds to invest, and the share price of those bond funds can fall dramatically if interest rates rise substantially. As a result, you can lose money investing in bonds.

More importantly, investing solely in bonds offers lower returns than the stock market has produced over the long run. If you're looking to make the purchasing power of your portfolio grow over time, the danger with bonds is that you won't find sufficient returns without buying bonds from issuers that are more likely to default.

Making bonds part of your investing portfolio is smart. But don't make the costly mistake of thinking bonds don't have any risk.

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