While the recent recession has taught us that nothing about the economy is a given, you might ask, "Is it safe to invest in corporate bonds?" The answer varies. If a corporation does well and can afford to repay the bond and pay your interest, then investing in corporate bonds is a good idea.
However, if you invest in bonds and the corporation goes under, you're left holding a worthless piece of paper. The idea of safely investing in corporate bonds is a bit of a misnomer; few investments relying on the security of a company are truly safe. The same thing goes for corporate bonds; some of them are good investments, while others bring only loss.
Only As Safe As the Company in Which You Invest
You shouldn't invest in corporate bonds unless you're willing to do the homework to determine the safety level of the corporation. Read annual reports to learn about the company's cash reserves, outstanding debt and profit projections. Does the corporation have a lot of capital improvements and expansion planned, or is it cutting back? Look for realistic responses to economic changes; a corporation that doesn't adjust in times of economic flux may be more likely to go down if the economy takes a sharp downturn. Corporate bonds are rated on a system that takes into account a corporation's history with repaying debts and creditworthiness; look for highly-rated corporate bonds to find some measure of security with your investment.
You Can Always Resell Them
A positive about investing in corporate bonds is that there is a large resale market for them. On some days, the corporate bond resale market reaches $23 billion; a savvy investor can buy corporate bonds and turn around and resell them when prices increase. You don't even need to hold the corporate bonds until maturity.
However, the resale market is subject to the same vagaries of the economy that afflict the corporation outright; if the corporation returns poor performance results, you'll have trouble unloading the corporate bonds before the company goes under. Therefore, reselling corporate bonds is effective only when the company is doing well; if the company begins to struggle, the resale market is virtually useless.
Different Levels of Safety
Corporate bonds aren't just a one-size-fits-all proposition; they come in different flavors with different levels of safety. If you're looking for more secure corporate bonds, invest in bonds based on collateral, mortgages or equipment trust certificates. Look for corporate bonds that are based on assets and physical equipment, which offer protection in case the company goes under. If you've got a higher level of risk tolerance, you can go for other types of corporate bonds: zero coupon bonds, convertible bonds, floating rate bonds, callable or putable corporate bonds, or step up or step down bonds.
Understanding the basics behind investing in bonds will help you decide whether this type of investment is right for you. Bonds are investment securities that represent debt obligations between the bonds' issuers, who are the borrowers, and investors like you, who are the lenders. In other words, bonds are essentially the IOUs of the corporate and government financial worlds.
When an investor, financial institution, mutual fund or foreign Government wants to protect itself from inflation, it may enter into one or more of several financial vehicles designed to protect their financial interests from inflation.