Bond Investments are Not Just for Boomers
The investment game is a curious and thrilling game of playing it safe while taking risks. This week we explore the stability of bonds, but not James Bonds (apologies - it was too tempting not to type), and how and when they might fit into your portfolio.
Names and personal information are excluded to protect privacy. NOTE: Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.
Q: What are bonds, how do they work and should I invest in them?
A: For the uninitiated, bonds are instruments of debt issued by local, state and federal governments and by business entities that guarantee the holders of those bonds a fixed amount of interest paid monthly, quarterly, semi-annually or annually. In short, if you buy bond(s), you are making a loan in the amount of the bond principal to the issuing entity.
Bonds for Boomers
Bonds have long been touted as “safe” investments because they guarantee the return of principal while generating periodic interest payments.
Revenue streams generated by bond investments are stable and predictable, which makes them popular investments for folks – often retirees – looking to generate regular income. In other words, the Silent and Boomer generations probably have investment portfolios heavy on bonds about right now.
A 100% bond investment portfolio is a bit too conservative for a young investor preparing for retirement several decades hence, but don't rule them out altogether.
A Safe Bet
Though deemed a "safe" investment, bonds carry varying degrees of risk depending on their maturities, which range from a few months to several decades, and the credit strength of the issuing entity. Bonds issued by the U.S. Treasury are the safest because the risk of a national government default on its financial obligations is minimal. Municipal bonds - those issued by local and state governments - are also low-risk and not subject to federal income tax, which often makes them one of the more tax-efficient investments available. Also, bonds issued by successful, highly rated U.S. corporations are low-risk investments.
Interest rates paid on "safer" bonds are usually less than rates paid on lower-rated companies’ “junk” bonds. But don’t eliminate junk bonds out-of-hand. The bond issuer’s stability just might be worth the trade-off depending on the circumstances.
You can choose which type of bonds to invest in based on your goals and risk tolerance.
Matters of Interest
Bonds provide interest income that often, but not necessarily, meets or exceeds the rate of inflation. Fluctuating interest rates impact the value of a bond positively or negatively, depending on the coupon rate. This becomes a factor if you sell the bond ahead of its maturity date. But once a bond matures, the issuing entity pays the bondholder the par valueof the bond regardless of its original purchase price.
Bonds offer the potential for capital gains if a bond is purchased at a discount, as well as its normal stream of interest income.
In the long-term, a good quality equity investment (i.e., company stocks and associated dividends) often outperforms a good quality bond. For this reason, younger investors should probably hold a greater percentage of equities vs bonds in their portfolios. But keep a close eye on your equities/bonds mix because as you grow older- and we all do - your bond allocation percentage should adjust more toward bonds.
Target-date funds are growing in popularity because they make adjustment to bond vs. equities allocations automatically over time. Check it out to see if your retirement fund offers this option.