Bond Basics for Your Portfolio:
Once viewed as a means of earning interest while preserving capital, bonds have evolved into a $90 trillion global marketplace that can offer many potential benefits to investment portfolios, including attractive returns.
Investors purchase bonds for several reasons: capital preservation, income, diversification and as a potential hedge against economic weakness or deflation.
Before tackling the complexities of this huge and diverse market, it is important to understand the basics: What is a bond and how can bonds help meet your investment goals?
What makes a bond a bond?
A bond is a loan that the bond purchaser, or bondholder, makes to the bond issuer. Governments, corporations and municipalities issue bonds when they need capital. An investor who buys a government bond is lending the government money. If an investor buys a corporate bond, the investor is lending the corporation money
Every bond also carries some risk that the issuer will “default,” or fail to fully repay the loan. Independent credit rating services assess the default risk, or credit risk, of bond issuers and publish credit ratings that not only help investors evaluate risk but also help determine the interest rates on individual bonds. An issuer with a high credit rating will pay a lower interest rate than one with a low credit rating. Again, investors who purchase bonds with low credit ratings can potentially earn higher returns, but they must bear the additional risk of default by the bond issuer.
In today’s world economy investors have access to International Bonds in Emerging and Developed Markets. One objective is seeking higher yield with lower duration while potentially keeping default risk moderated.
Bond Investment Strategies, which can be either passive or active depending on the investor’s goals, should first be reviewed with a Financial Advisor. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield. Government bonds are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.
About the Author: Charles Marsala is a Financial Advisor with Benchmark Investment Group with Securities offered through LPL Financial, a member FINRA/SIPC. He can be contacted at Charles.Marsala@lpl.com