A bond is a debt instrument, or simply a loan from the
investor to the issuer. In return for the loan, the investor is paid
interest on a periodic basis and at maturity the full principal is
returned. Bonds have a stated maturity date and a fixed coupon or interest
payment. This is why bonds are called fixed income investments. The price
of a bond will fluctuate with changes in the interest rate environment.
Bond prices move inversely to interest rates; as interest rates rise, bond
prices fall and as interest rates fall, bond prices rise. There are many
types of fixed income investments and each has unique characteristics
depending on the issuer. These characteristics include credit quality of
the issuer, coupon payments, final maturity dates, and tax implications.
In fact, the bond market is much larger than the stock
market. Outstanding bond issues stand at over $13 trillion. The bond market
offers investors a lot of choices, so it is important to have a clear
picture of your investment objective before selecting appropriate
investments for your portfolio.
Why Do Investors Buy Bonds?
The bond market offers investments that can help achieve
many different investment objectives — including income generation,
portfolio diversification, and even growth.
Income Generation - Traditional
interest-bearing bonds pay interest semi-annually, quarterly, or in some
cases monthly. These payments on traditional bonds are fixed and cannot be
changed over the life of the bond. This regular income schedule benefits
investors who rely on the income from their bonds to meet living expenses.
At retirement, investors often move a percentage of their portfolios into
bonds to meet annual living expenses.
Growth or Total Return - Because bond
prices move with fluctuations in interest rates, it is possible to generate
growth with bonds. As rates fall, bond prices will move higher. Investors
who believe that interest rates will fall or who believe that a certain
sector of the fixed income market will outperform can realize growth from
their bonds. Investors seeking growth within the bond market should consult
with their Financial Advisor to identify appropriate bonds. Bond prices
fluctuate just like stock prices, so investors who purchase bonds for
growth must be able to withstand that volatility or hold onto their
investments until maturity.
Portfolio diversification is not a new concept. Many
investors follow an asset allocation approach to investing. Asset
allocation is simply the allocation of investment dollars across asset
classes like stocks, bonds and cash. When one sector of the market is
faring poorly, another sector is traditionally outperforming. By
diversifying across asset classes, portfolio volatility can be reduced. In
addition, many investors like the comfort of knowing that on the dates
their bonds mature, their principal will be returned to them.
The biggest question for many investors is how much
of your portfolio should be in bonds
Once you have set your overall asset allocation, you and
your Financial Consultant can begin to take into account additional factors
to identify the types of bonds that suit your investment objectives.
What is your investment time horizon? Is there a funding
need, like a child's college tuition, that will need to be met in the
future? This will help you determine the appropriate maturity dates of
Do you have specific income needs that must be met? This will help
determine the coupon payment dates as well as interest rates required on
What is your tax bracket? Are you purchasing bonds in a tax-advantaged
account like an IRA? This will help determine whether you should buy
taxable or tax-exempt bonds.
What is your risk tolerance in respect to your bond purchases? Are you
willing to take some additional risk to secure a higher yield? This will
help determine the minimum acceptable credit quality or rating on bond
Do you seek growth from your bond investments? This will help determine
which sector of the bond market you should be focused on.
What Type of Bond Investment Is Right for Me?
A bond mutual fund offers professional management for a
fee, a monthly income stream, and portfolio diversification. The value of a
bond fund, like that of an individual bond, will fluctuate with movements
in interest rates. Individual bonds, however, offer fixed income payments
and stated maturity dates. An individual bond does not offer professional
management, annual fees, or diversification. However, individual investors
who have enough money to buy several different issues can purchase a
laddered portfolio of bonds and reap many of the benefits of a bond fund
without paying management fees.
For more information on how bonds fit into your overall
investment objectives, consult with your Financial Consultant. He or she
can help you determine how much of your portfolio should be in bonds as
well as what types of bonds will best meet your