Investing in Bonds
After the beating many investors have taken on stocks over the last eighteen months, some people are waking up to a not-so-new concept, portfolio diversification. In other words, all stocks in your portfolio may not be the best way to invest. THAT MONEY SHOW invited Eric Tyson, author of INVESTING FOR DUMMIES and a financial counselor, to share some tips on investing with bonds.
Why invest in bonds?
During the later 1990s investors were excited to be in stocks. They were getting excellent returns then -- sometimes fifteen or twenty percent -- and they were wondering why they should put any of their money in bonds. Now, however, they're beginning to understand that bonds provide diversification. Sometimes when stocks go down in value, bonds actually appreciate and help to offset the losses or volatility of the stock market.
What's different about bonds?
Most of the return you're going to get from a bond is from the dividends, or interest, that's paid out on it. Most are paying about 6 or 7 percent, and that's a reasonably secure stream of return that you'll be getting over time. With stocks, the bulk of your return, you hope, will come from appreciation over time, and could actually end up being depreciated, which is what we've seen in the last year or two.
Certainty
If you're investing in high-quality bonds -- bonds that have a high-quality credit rating with the ability to pay you back at the term of the bond -- during the time that you hold the bond you'll get your interest payments, and you'll get your principle returned at the end of the term.
Asset Allocation
Take your age, subtract it from 110, and that's the portion you should be putting in stocks. For instance, a thirty-five year old would subtract his or her age from 110 and get 75. That would mean 75 percent of the person's investments should be going into stocks, and twenty-five percent should be going into bonds.
Kinds of Bonds
There are many kinds of bonds available. For instance, taxable bonds are made up mostly of corporate bonds issued primarily by large- and medium-sized corporations. Those bonds pay taxable dividends (interest payments) taxable at the state and federal level. Municipal bonds are issued by state and local governments. They are generally federally tax-free, and the interest payments may be state-tax-free if they're issued in the state in which you file your taxes.
Bond Funds
A bond fund is a managed investment portfolio. You've got a management team whose full-time job is to select bonds to make up a portfolio. You're leaving the driving to someone else if you're investing in a bond mutual fund. On the other hand, you can go out and purchase individual bonds yourself, but if you do that you're going to have to spend a lot of time doing research and tracking of the bonds over time. You're also at more of a risk of a bond default because you don't have the expertise of a professional fund manager.
Do-it-Yourself?
To build a truly diversified bond portfolio on your own, you'll need at least $100,000 or more to invest. In addition to having a six-figure investment balance, you also need a lot of free time to manage the investments. So, the average person is probably better off purchasing a bond mutual fund instead of trying to do it alone.
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