The pitfalls of monthly interest paying bonds: Why they may not be a good investment

Date : 16/09/2023
Read: 3 mins

Before jumping into seemingly attractive monthly interest-paying bonds, it's essential to understand the potential drawbacks and why it may not always be a good choice.

Are interest-paying bonds better?

While monthly interest-paying bond investments offer the appeal of a regular income, they may not be the best choice for everyone. The lower yields, limited capital appreciation potential, interest rate and reinvestment risks, illiquidity, and lack of diversification should all be carefully considered before investing in these bonds. Investing in bonds has long been considered a stable and relatively low-risk way to grow one's wealth, especially for conservative investors looking for a steady income. Moreover, monthly interest-paying bonds have gained popularity for their regular income disbursements.

Highlights:

Monthly interest-paying bonds are suitable only for investors seeking a regular income.
Re-investment of this earned income is essential to get compounded returns
Bonds are for a fixed tenure and hence, offer limited or no liquidity
Investors should carefully consider the potential disadvantages of monthly interest-paying bonds

Also Read: Retirement planning by LIC Jeevan Shanti Plan

Advantages of interest paying bonds investment

Interest-paying bonds enable the availability of cash at regular intervals, which is convenient for pensioners, and investors looking to meet routine expenses through this income. Also, since bonds, though negligible, carry a default risk, having earnings in hand beforehand steadily decreases the amount at risk.

Disadvantages of interest-paying bonds

However, investing in monthly interest-paying bonds, while offering a predictable income, comes with several notable disadvantages. Firstly, these bonds typically offer lower yields compared to counterparts, such as annual interest-paying bonds. This can lead to reduced returns over time, especially when inflation erodes the purchasing power of the income generated.

Secondly, if interest rates rise, the fixed interest payments from these bonds become less attractive in comparison to newer issues with higher rates.

Although bond interest offers stability to the portfolio, they fail to beat inflation. In such cases, one has to ensure that the accrued interest is put to productive use. The money needs to be invested from time to time to improve the overall portfolio returns and compound the money.

Additionally, reinvestment risk is a concern. When monthly interest payments are received, investors must find suitable reinvestment opportunities. If not reinvested, the earnings will yield minuscule returns lying in bank accounts or may be spent in inappropriate ways.

Also, monthly interest bonds are often less liquid than more widely traded securities, making it challenging to sell them quickly if the need for liquidity arises

Conclusion: While monthly interest-paying bonds offer consistent income, investors should carefully consider the potential disadvantages, such as lower yields, interest rate and reinvestment risks, liquidity challenges, and limited diversification, before committing to this investment option.

Disclaimer: This article is intended for general information purposes only and should not be construed as investment tax or legal advice. You should separately obtain independent advice when making decisions in these areas.