7 Steps of Investing Basics – Step 4 Bond Investing

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STEP 4 – TYPES OF INVESTMENTS – BONDS

Prepared by William Edward Blanken Jr

How do bonds work?

When you buy a bond, you’re basically buying an IOU. Bonds, sometimes called fixed-income securities, are essentially loans to a corporation or governmental body. The borrower (the bond issuer) typically promises to pay the lender, or bondholder, regular interest payments until a certain date. At that point, the bond is said to have matured. When it reaches that maturity date, the full amount of the loan (the principal or face value) must be repaid.

A bond typically pays a stated interest rate called the coupon, a term that dates back to the days when a bondholder had to clip a coupon attached to the bond and mail it in to receive each interest payment. Most bonds pay interest on a fixed schedule, usually quarterly or semiannually, although some pay all interest at maturity along with the principal.

There are two fundamental ways that you can profit from owning bonds. The most obvious is the interest that bonds pay. However, you can also make money if you sell a bond for more than you paid for it. As with any security, bond prices move up and down in response to investor demand; they also are sensitive to changes in interest rates. Bonds redeemed prior to maturity may be worth more or less than their original cost, and those that seek to achieve higher yields also involve a higher degree of risk.

The role of bonds in your portfolio

One of the most important reasons that investors choose bonds is for their steady and predictable stream of income through interest payments. Bonds have traditionally been important for retirees for this reason. Also, though they are not risk-free–for example, a bond issuer could default on a payment or even fail to repay the principal–bonds are considered somewhat less risky than stocks. In part, that’s because a corporation must pay interest to bondholders before it pays dividends to its shareholders. Also, if it declares bankruptcy or dissolves, bondholders are first in line to be compensated.

Ways to Classify Bonds
By maturity
  • Long-term (10+ years)
  • Intermediate (1-10 years)
  • Short-term (less than 1 year)
By issuer
  • Corporate
  • Municipal
  • U.S. Treasury
  • Government-sponsored entities
  • Foreign corporations and governments
By quality
  • Investment grade
  • High yield (“junk”)
By tax status
  • Tax-exempt: municipal bonds (generally exempt from federal tax)
  • Taxable: corporate, U.S. Treasury (exempt from most state and local tax)

 

The bond market often behaves very differently from stocks. For example, when stock prices are down, investors often prefer bonds because of their relative stability and interest payments. Also, when interest rates are high, bond returns can be attractive enough that investors decide not to assume the greater risk of stocks. Interest from bonds can help balance stock fluctuations and increase a portfolio’s stability. And because a bond’s face value gets repaid upon maturity, you can choose a bond that matures when you need the money.

Some bonds are exempt from federal or state and local income tax. This can be appealing to investors in high tax brackets.

Advantages
  • Generally, a predictable stream of income
  • Income typically higher than cash investments
  • Relatively lower risk compared to stocks
  • Low correlation with stock market
Tradeoffs
  • Risk of default
  • Bond values fluctuate with interest rates
  • Generally, lower potential returns compared to stocks

 

 

BLANKEN MANAGEMENT INC DISCLOSURES

The investment advice provided along with the strategies suggested by Blanken Management will vary depending on each client’s specific financial situation and goals. There are risks involved while investing in securities. Considering the risks, you should fully understand the nature of the contractual relationship into which you are entering and the extent of your exposure to risk. Certain investing strategies may not be suitable for many members of the public. You should carefully consider whether the strategies employed will be appropriate for you considering your experience, objectives, financial resources, and other relevant circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

This communication is strictly intended for individuals residing in the state(s) of FL. No offers may be made or accepted from any resident outside the specific states referenced.

Prepared by Broadridge Advisor Solutions Copyright 2020.


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