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
Typically, short-term bonds offer much smaller yields but are considered less risky, so they're at the lower left-hand side of the graph. Longer-term bonds generally provide larger yields because the uncertainty about future events makes them riskier. They're usually in the upper right-hand side of the graph.
What is the difference between long-term and short-term bonds? ›
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.
What are the 3 major disadvantages in using bonds for long-term financing? ›
Cons
- Historically, bonds have provided lower long-term returns than stocks.
- Bond prices fall when interest rates go up. Long-term bonds, especially, suffer from price fluctuations as interest rates rise and fall.
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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.
What are the pros and cons of short term bonds? ›
Short-term government bonds offer a range of benefits, including safety and stability, but investors should be aware of the potential risks, such as lower returns and inflation risk. Understanding the pros and cons can help you make informed investment decisions based on your financial goals and risk tolerance.
What is the risk of long term bonds? ›
Long bonds offer one advantage of a locked-in interest rate over time. However, they also come with longevity risk. When an investor holds a long-term bond, that investor becomes more susceptible to interest rate risk since interest rates could potentially increase over a long-term period.
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.
Should you buy bonds when interest rates are high? ›
Should I only buy bonds when interest rates are high? There are advantages to purchasing bonds after interest rates have risen. Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels.
What are the three major risks when investing in bonds? ›
- Credit Risk — The risk that a bond's issuer will go into default before a bond reaches maturity.
- Market Risk — The risk that a bond's value will fluctuate with changing market conditions.
- Interest Rate Risk — The risk that a bond's price will fall with rising interest rates.
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What is the outlook for bonds in 2024? ›
As inflation finally seems to be coming under control, and growth is slowing as the global economy feels the full impact of higher interest rates, 2024 could be a compelling year for bonds.
Why do investors prefer short-term bonds? ›
The main advantage of short-term bonds is their ability to generate current income with relatively low risk. For this reason, short-term bonds can be a good choice for many investors' portfolios. Like other bonds, short-term bonds are subject to two main types of risk: interest-rate risk and credit risk.
Are short-term or long term bonds better in a recession? ›
When the interest rate drops during a recession, the yields paid on bonds can decline. Because of this, some investors prefer to hold short-duration bonds that mature quicker than long-term bonds. With long-term bonds, you could potentially lose more money on your initial investment.
What is the difference in long term and short term? ›
Goals that can happen quickly are called short-term goals. Goals that take a long time to achieve are called long-term goals. Find out more about them. A short-term goal is something you want to do in the near future.
Are long or short term bonds riskier? ›
Short-term bonds are bonds whose maturity takes a period of one to four years. These bonds are less risky, and they pay a lower interest rate. Long-term bonds, on the other hand, are bonds whose maturity takes more than fifteen years. These bonds are riskier than short-term bonds but pay higher yields or interest.
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.
