Investing in domestic bonds have a bad reputation for its safety. You can easily lose your money due to interest rate risk, inflation risk, or credit risk. Here, we will learn the ways to use investment-grade bonds to avoid credit loss, the latter risk.
Many times, inexperienced investors are interested in high-interest bond, commonly known as junk bonds. Yet, these investors fail to consider the high probability of default from those bonds. Instead of gaining profits, these investors get the notification that the business has gone into bankruptcy.
Thus, it is better for bond investors to purchase a conservative bond fund or bond index fund. These bonds have no leverage and operate at a low cost.
Always Consider the Credit Risk When You Invest in Bonds
You have to remember, that every time you lend your money, whether it is to your friend or to a giant business, there is always a probability that you do not get your money back. Many unexpected things can happen.
Thus, you need to consider a company with a stronger income statement, cash flow statement, and balance sheet. The lower interest rates you get, the lesser the chance of you losing all of your capital. This rule will stay true regardless of other factors.
For municipal bonds, the ones you pay for government projects, you can run several tests to protect your investment. Meanwhile, for corporate bonds, you have to work on financial statements to find the company’s credit quality.
The Poor and Standard Investment Grade Bonds Rating
Many people consider investment-grade bonds are safer than the other types of bonds. This is because grade bonds issuers own a good capacity to repay the obligations.
Government of a country usually demand the institutions to have several things before they issue grade bonds. Here is the classification of grade bonds that you have to know.
AAA
It is for institutions with an extremely strong capacity to fulfil financial commitments.
AA
It is for institutions with a strong capacity to fulfil financial commitments.
A
It is for institutions with an extremely strong capacity to fulfil the financial commitments, yet also susceptible to possible changes in economic condition.
BBB
It is for institutions with adequate capacity to fulfil the financial commitments, yet more subject to adverse economic conditions.
