Are bonds worth investing in?

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While stocks may come to mind first when you think about investing, another major investment category is bonds. They can not only add diversification to an investment portfolio — an important ingredient in protecting against market volatility — but they also tend to be a safer investment than stocks. However, with bonds’ lower level of risk comes a lesser potential for reward, and their risk is not non-zero.

Here is what you need to know about this major asset class to decide whether — and how — to include them in your investment portfolio.

How do bonds work?

A bond is a “loan to a company or government that pays investors a fixed rate of return,” said NerdWallet. So while “the borrower uses the money to fund its operations,” in exchange, the investor “receives interest on the investment.” Interest on bonds is paid at “regular intervals,” usually two times a year, which is why bonds “are often referred to as ‘fixed income investments,'” said CNBC Select.

To purchase a bond, you “first pay the bond’s issuer the face value (or price) of the bond,” and from there, the bond’s issuer “pays you interest for loaning them money across the life of the bond in return,” said NerdWallet. When the bond reaches its maturity date, the principal amount “must be paid back in full or risk default,” said Investopedia.

What are the benefits of investing in bonds?

Two of the major benefits of bonds are their relative safety and predictability. “Bond values don’t fluctuate as much as stock prices,” and bonds also “offer a predictable income stream, paying you a fixed amount of interest twice a year,” said The Motley Fool. Credit ratings add another layer of security to bonds, as some types have these ratings “to show investors the likelihood that they’ll get repaid on their investments,” said CNBC Select.

Bonds are also a good way to diversify your portfolio and provide risk and downturn protection. Because “bonds generally have a low correlation to stocks,” their “value is often up when stocks are down and vice versa,” said U.S. News & World Report. Plus, “when the economy slows, falling inflation increases the purchasing power of future bond payments.”

Do bonds have downsides?

Of course, bonds have drawbacks as well. For one, the return on investment you will get from bonds is “substantially lower than what you’ll get with stocks,” said The Motley Fool.

While they may have less risk, there is still the possibility of the issuer defaulting and interest rates falling. There is always the “potential for a bond’s value to fall in the secondary market due to competition from newer bonds at more attractive rates,” said Investopedia, not to mention the chance that “inflation will erode the value of a fixed-price bond issue.”

Should you invest in bonds?

The bottom line: “As a general rule of thumb, bonds can be a great addition to your investment portfolio when used strategically alongside stocks and other assets,” said NerdWallet. While bonds do still carry some risk, it generally is lower than that of stocks. Plus, “if you’re heavily invested in stocks, bonds are a good way to diversify your portfolio and protect yourself from market volatility,” said The Motley Fool. Just make sure to consider your broader investment goals and do your due diligence before committing.