You Could Lose a Lot of Money in Bonds: Holders of Greek Debt are finding this to be true. But you can also lose a lot of money in stocks as well - in fact all of it, for example, if you bought GM a few years ago. Even the Greeks are offering 50 cents on the dollar, which is a lot more than I got out of GM.
Oftentimes, debts are "worked out" this way. For example, I discussed the Mohegan Sun, whose bonds fell so far in value that the effective rate of return skyrocketed to 240%. The dust is still settling on that one, but the Casino is not defaulting just yet - but is offering the bondholders new bonds, when the old ones come due, at an even higher interest rate. The interest payments would still be made, but the principal would not be paid back until 2016 (at which point, it might be extended yet again).
If the plan is approved, the bond holders are not wiped out, but continue to hold debt and collect interest. Things could be worse. That scenario, however, is unique, as by law, only Indian Tribe members can hold stock, so bondholders are not protected if they decide to declare bankruptcy.
But for most situations, even if the company goes bankrupt, as bond holder, you are first in line for the pickin's - and often this means stock in the new company. Even in the GM bankruptcy, which some claim screwed the bondholders, the bondholders got 30 cents on the dollar. And while that might sound like a screw-job on the bondholders, bear in mind that just prior to bankruptcy, you could buy GM Corporate Debt pretty cheaply - for less than 30 cents on the dollar. Some people made out in that deal.
So are bond a good or bad deal and should you invest in them? Yes, No, and Maybe. First of all, they are deceptively complex. They appear to be simple interest-bearing notes, but since they are traded like stocks, they have a market price, just like stocks, and an effective rate of return that can vary from the face value of the bond (the so-called "coupon rate" although most bonds today do not have detachable coupons). And if you don't understand any of what I just said, you probably have no business buying bonds in the first place.
Diversification is important in any investment strategy. And while corporate or municipal bonds, as well as U.S. Treasury debt instruments are a good adjunct to any investment portfolio, putting all of your money into them is probably a bad idea, particularly when you don't know what you are doing.
What started me on this thread was the fact that I own some GE stock and some GE corporate bonds. The stock is in the tank right now (down 46%) while the bonds are worth 6% more than I paid for them. GE is struggling right now (and yet, people criticize it for not paying corporate taxes!) and its huge debt load is part of that problem. But if they did go out of business (which I obviously am betting won't happen) which do you think will be worth more - my GE stock or my GE bonds?