For investors, the choice of which bond to buy can be tricky.
Bond investors face a big choice when they have money to invest: Should they pick long-term bonds or short-term bonds for their portfolios? Both types of bonds have advantages and disadvantages, so there's no one right answer for everyone. Instead, you have to look at the pros and cons of both long- and short-term bonds to see if the rewards outweigh the potential problems.
Short-term bonds
Short-term bonds are attractive to many investors because they don't require you to tie up your money for long periods of time. They're suitable for those who will need to spend their invested money in the near future, but they can also be useful even for long-term investors. For instance, if you expect a rise in interest rates over the short run, then investing in a short-term bond will let you reinvest the money at maturity in a bond that by then should be paying a much higher interest rate.
The downside of short-term bonds is that they generally pay lower interest rates than long-term bonds. As a result, in order to get the benefits of a short-term bond, you typically earn less income, forcing you to make sure that the advantages short-term bond investing brings are truly worth it for you.
Long-term bonds
Long-term bonds have much different attributes from short-term bonds. With a long-term bond, you'll typically earn a higher interest rate, as the entities that issue the bonds will be willing to pay more in interest in exchange for the security of locking in a known rate for a longer period of time. If you need to maximize income, then a long-term bond can look extremely attractive.
The downside of long-term bonds is that you lack the flexibility that a short-term bond offers. If interest rates rise, for instance, the value of a long-term bond will usually go down, penalizing you for having committed to a locked-in rate for the long haul. In addition, depending on the issuer, a long-term bond can have a greater risk of default -- especially if the same issuer has other outstanding bonds that mature before the bonds you own.
Solving the dilemma
Most investors end up having a mix of short- and long-term bonds in their portfolios in order to get the best of both worlds. Yet the question still remains how much to invest in each kind, and how you answer that will depend on which traits of each type are more attractive to you. Both short- and long-term bonds are suitable investments for most portfolios. Visit our broker center to set up an investing account and buy either -- or both -- today.
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FAQs
Long-term bonds have a greater duration than short-term bonds. Duration measures the sensitivity of a bond's price to changes in interest rates. For instance, a bond with a duration of 2.0 years will decrease by 2% for every 1% increase in rates.
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What are the 3 major disadvantages in using bonds for long-term financing? ›
Bonds have some advantages over stocks, including relatively low volatility, high liquidity, legal protection, and various term structures. However, bonds are subject to interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk.
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What are the disadvantages of short-term bond funds? ›
The downside to owning bond funds is: The management fee: Management fees for the more actively traded bond funds can be higher, which may lead to lower returns.
Should I buy short or long-term bonds now? ›
We suggest investors consider high-quality, intermediate- or long-term bond investments rather than sitting in cash or other short-term bond investments. With the Fed likely to cut rates soon, we don't want investors caught off guard when the yields on short-term investments likely decline as well.
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The majority of reviews rate Motley Fool positively overall. But there are some complaints about high pressure sales tactics, misleading claims and poor customer service response. Despite some negatives, most say the stock research merits the membership fee.
Why is a bond not a good investment? ›
There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall.
High-yield or junk bonds typically carry the highest risk among all types of bonds. These bonds are issued by companies or entities with lower credit ratings or creditworthiness, making them more prone to default.
Is it better to invest in stocks or bonds? ›
As you can see, each type of investment has its own potential rewards and risks. Stocks offer an opportunity for higher long-term returns compared with bonds but come with greater risk. Bonds are generally more stable than stocks but have provided lower long-term returns.
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Let's say that you start with the time frame in mind, hoping an investment will double in value over the next 10 years. Applying the Rule of 72, you simply divide 72 by 10. This says the investment will need to go up 7.2% annually to double in 10 years. You could also start with your expected rate of return in mind.
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What is the difference in long term and short term? ›
Short-term goals are likely measured by weeks, months, or quarters. Long-term goals can be measured by years and may have an undefined timeline. It is much easier to achieve short-term goals because you can easily see progress. Long-term goals are difficult and require patience as there is no immediate obvious payoff.
What is a short-term bond? ›
Short-term bond funds invest primarily in corporate and other investment-grade U.S. fixed-income securities and generally have durations1 of one to three and a half years.
What is the main difference between short term and long term interest rates? ›
A short-term interest rate is the interest rate charged on a short-term loan. A long-term interest rate is the interest rate charged on a long-term loan. The major difference between a short-term interest rate and a long-term interest rate is the length of time it takes to pay back the loan.
Is short term better than long term? ›
Final thoughts on long-term investing vs short-term
Both approaches have their potential benefits, but long-term investing potentially provides an increased chance of a higher return through compound growth and the recovery of losses over time.
