Should You Go For Debt Investments In 2024? (Pros And Cons)

by Anthony Zhang

Debt investing is not reserved for large banks anymore.

You heard it right!

Owning debt helps you earn lucrative returns if you plan and choose the right asset.

But are debt investments the right choice for you? And which are the best debt investments in 2024?

This article answers all your questions - what is debt investment, three amazing debt investments in 2024, and how it differs from equity investment.

We’ll also discover some pros and cons of investing in debt and how you can diversify your portfolio with fine wine investing.

What Is Debt Investment?

Debt investment is a type of investment you make in a company or project by purchasing a large quantity of debt.

As an investor, you will not only earn back the amount paid to the debtor but also earn an impressive return based on the interest rate at which you got the debt.

There are two types of debt investments:

Secured Debt: Secured debt is provided on underlying collateral. If the borrower is unable to pay the debt, the debtor can forfeit the underlying asset.
Unsecured Debt: Unsecured debt doesn’t have collateral. It is backed chiefly by the borrower’s creditworthiness.

Before investing in debt, consider these three questions:

What type of firm you’re investing in?
Why they’re looking to sell?
What type of return can you expect to earn?

Most investors use debt investing as fixed income because borrowers are legally required to pay back a specified amount at predetermined intervals.

Now:

Which debt investments are worth adding to your portfolio?

3 Rewarding Debt Investments to Go For In 2024

These three debt investments offer lucrative returns:

Corporate Bonds
Treasury Securities
Loans

1. Corporate Bonds

Bond is the most common debt investment asset. In this investment, debt investors loan money to a company or organization for a defined period and interest.

In this investment, investors buy bonds with a guaranteed repayment at a predetermined interest rate.

Some bonds offer call protection, which limits the ability of the borrower to pre-pay the bonds before a certain period.

However, investing in bond can be a little tricky. Companies with higher credit scores and good credit history would want to pay a much lower interest since they are more secure to invest in.

On the other hand, companies with a low credit rating (a bad credit history) would be much riskier to invest in, even though they would agree to a higher interest rate. Investing in a financially distressed company is called distressed debt investment.

2. Treasury Securities

Treasury securities are backed by the Federal Reserve. That’s why these debt investments come with little-to-no credit risk.

You can purchase treasury securities online or through auctions in increments of $100.

Based on maturity period, there are three types of treasury securities:

Treasury Bills: issued for 4, 8, 13, 26, and 52 weeks
Treasury Bonds: issued for 30 years
Treasury Notes: issued for 2, 3, 5, 7, and 10 years

Since you buy these securities from the government, it is attractive to both - individual as well as an institutional investor.

3. Loans

Another much safer option than bonds is a loan.

Bank Loans (or leveraged) are highly regulated, and the borrower goes through a comprehensive screening process to ensure their creditworthiness.

They are floating rate instruments. Quarterly interest payments are typically adjusted based on a reference rate like the 90-day SOFR (Secured Overnight Financing Rate.)

Additionally, loans are pre-payable, meaning borrowers can repay the loan before the fixed date in case of an excess cash flow.

If you don’t wish to invest in debt directly, you can go for a mutual fund that invests in debt. These are called debt funds.

The question is:

How does debt financing differ from equity investments?

Debt Financing Vs Equity Financing

Debt financing is when a firm raises money for capital expenditures with the motive to return it (at a predetermined rate of interest.) In such cases, the lender doesn’t own the company's share. Debt investment allows an investor to become a creditor by buying the company’s fixed income products like bonds, bills, or notes.

On the other hand, in private equity financing, the investor buys shares of private company stock through a public offering. Meaning, equity investments allow you to become a member of the company.

What if a company goes bankrupt?

In case a company goes bankrupt, creditors’ claim on any liquid asset is greater than its shareholders. So, debt financing can prove to be beneficial.

However, if the company’s sales skyrocket, you may miss out on some rewarding profits.

Pros and Cons of Debt Investments

Here are the advantages and disadvantages of investing in debt security in a nutshell.

Pros of investing in debt include:

Debt payments must be made regardless of business revenue.
You can become a creditor without taking responsibility for a company’s daily operations.
Since debt payments are made periodically, many debt investors use them as passive income.

Cons of investing in debt include:

Debt financing allows businesses to leverage a small amount of money into a much larger sum. However, as a creditor, you get paid a fixed amount.
A company with a good credit score may not agree to pay a good interest rate. So, to earn good returns, you might have to go for a company with a not-so-good credit history.

Before investing in debt, here are a few things you need to consider.

Things to Consider Before Investing In Debt

There are three factors you should consider:

Cost of Debt
Higher Credit Risk
Difficult to Obtain

1. Cost of Debt

Before investing in a company, you need to consider the firm’s cost of debt. Here’s what it is.

A company’s capital structure is made up of equity and debt.

The cost of equity financing and the cost of debt financing together form the cost of capital. The cost of equity represents the payments to shareholders, while the cost of debt represents the interest payments made to bondholders.

The interest rate paid on these debt instruments represents the cost of borrowing to the issuer.

If the company already has a high cost of debt, it may not be able to fulfill its financial obligations.

Another reason why the cost of capital is important is that the cost of capital represents the minimum return a company earns to satisfy its shareholders, creditors, and other investors. Typically, a company’s investments for new projects are made based on its cost of capital.

In layman’s terms, if a company’s return on capital is below its cost of capital, the firm is not generating enough profits. This calls for a re-evaluation of its capital structure.

2. Higher Credit Risk

Debt investments are riskier than most other investment classes, including real estate and wine.

If you’re looking for private debt investments with a higher interest rate, you’ll have to go for companies with a poor credit score, which increases the level of risk.

Remember, even though a higher interest rate tries to compensate the borrower for the increased risk, you may still lose some money if the company goes bankrupt.

3. Difficult to Obtain

Debt investing can be a bit complex. In fact, asset managers would probably advise a new investor against it.

The reason?

It is quite difficult to find the perfect debt investment opportunity. Most companies would agree to a much lower interest rate than you expect simply because debt increases the overall cost of a company’s capital.

Also, you’ll have to study a company’s investor relations before giving them credit.

However, there are much better alternative investments like a mutual fund, real estate, or equity investment that come with lesser risks and similar returns. Consult professional asset managers like Morgan Stanley to get reliable investment advice and form a perfect investment strategy.

Is there a better investment than equity securities or debt?

Diversify Your Portfolio With Fine Wine Investing

Wine is a profitable alternative investment that offers rewarding returns to investors globally. Since the wine market has a low correlation with the sluggish global stock market, this asset class also offers a great hedge against the stock market crash.

Compared to other investments like gold and real estate, fine wine can be much more rewarding for an investor.

While gold’s average 5-year return is 45.6%, wine’s 5-year return stands at 50.3%.

Furthermore, the 25-year return for private commercial real estate investment averaged 10.3% in the first quarter of 2021. Additionally, Real Estate Investment Trusts (REITs), like the Real Estate Select Sector Fund, generated 22.9% returns over the past year.

Wondering why it offers such great returns?

Fine wine appreciates over time. As its quality increases, so do its demand and value. Also, over time, due to consumption, a fine wine’s scarcity also increases, raising its price.

But, how do you invest in wine?

The easiest way to invest in fine wine is through a reliable wine investment company like Vinovest.

It will help you select the investment grade bottles, buy them for you, and store them in climate-controlled warehouses.

Vinovest will even help you sell your wine when you’re ready. However, fine wine typically takes 5-20 years to reach its peak. To get the best out of your investment, it is best to sell it at the right time. Don’t worry; Vinovest’s advisors will take care of it for you.