Investors are constantly looking for investment instruments that ensure the growth of their purchasing power. And this is normal, since the main objective of any investor is to guarantee their return and minimize the risk of losses. In this scenario, inflation-linked bonds stand out as an attractive option, especially because market volatility can significantly impact the expected return.
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ToggleWhat are inflation-linked bonds?
Inflation-linked bonds are fixed-income debt instruments whose yield is structured according to a specific index, such as the Consumer Price Index (CPI), the Gross Domestic Product (GDP) or the fluctuation of a currency. These assets preserve their nominal value, but undergo periodic adjustments that align them with inflation variations.
As a mechanism, it provides an effective hedge against the erosion of the investor’s purchasing power, while allowing the issuer to manage the risk inherent in a volatile economic environment. By purchasing an inflation-indexed bond, the investor not only receives periodic interest payments, but also sees an increase in the amount of his initial investment, which is adjusted upward in line with inflation. For example, if an investor purchases a bond for 1,000 euros and inflation increases by 3% during the year, the face value of the bond will be adjusted to 1,030 euros, reflecting the inflationary impact.
For investors, this type of product represents an effective strategy, as it guarantees a return on investment and ensures that purchasing power does not devalue over time.
Advantages of inflation-linked bonds
Inflation-linked bonds provide investors with quality assets with high diversification potential and rates of return that correspond to market reality. Their main advantages are as follows:
- Inflation Protection: Since both the principal and interest are adjusted for inflation, investors have the peace of mind that their capital and purchasing power will not be negatively affected over time.
- Adjusted return: One of the key advantages of inflation-indexed bonds is that the real return and inflation adjustment ensure that investors receive a return that maintains its value over time.
- Low risk and protection: In the investment arena, inflation-indexed bonds are considered low-risk instruments. This is largely because they are issued by the governments of each country, which provides an additional guarantee and security for investors. If they present solvency in their issuance, they minimize the risk of default, which makes these bonds a beneficial option for those seeking stability.
- Long-term investment horizon: A particularity of these financial instruments is that their maturity is usually stipulated in the long term. Thus, investors can benefit from accrued interest and inflation adjustment over time, while capital grows and interest yields are earned.
Disadvantages of inflation-linked bonds
As well as having advantages, inflation-linked bonds also have certain disadvantages that investors should consider when choosing these investment tools, especially considering that their investment requires a long-term risk management strategy.
- Sensitive to interest rate changes: If you invest in inflation-linked bonds, you should be aware that when interest rates rise, the price of bonds generally declines. This is because investors seek higher yields on newly issued bonds, negatively impacting the value of existing bonds, on which lower interest rates fall. In addition, it is critical to consider credit risk when investing in bonds, as the creditworthiness of the issuer directly influences the safety and return on investment.
- Potentially lower yield: Although they offer protection against erosion of purchasing power, their nominal return may be lower compared to other riskier assets such as corporate bonds or equities. This characteristic is due to the conservative nature of index-linked bonds, which prioritize investment stability and security, rather than maximizing returns. Nevertheless, it is still profitable for investors seeking a safe return.
- Lower liquidity: It is important to note that the liquidity of certain inflation-indexed bonds may be limited, making it difficult to sell these instruments in the secondary market. Unlike other more common bonds, some index-linked bonds may not have an active market, making them difficult to buy and sell.
Do you want to invest in inflation-linked bonds? Choose inbestMe
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