Insider Jeff Fleming

To Bond or Not to Bond

When developing your investment portfolio, you might consider devoting a portion of it to bonds. You've probably heard that bonds are a great way to safely round out your investments. Jeff Fleming reviews the pros and cons.

Unlike stocks, bonds do not represent ownership in the issuing entity. Instead, as a bondholder, you are essentially a creditor: the money used to buy the bond is a loan to the borrower (which may be a corporation, a municipality, or the U.S. government). There are many bonds available to the investor today. Corporate bonds, government bonds, junk bonds, Series E, EE, H, and HH bonds, even bond funds and unit investment trusts, fall into the "bond" category, but operate in a slightly different manner. Consider these factors in your bond strategy.

Varying Risk
The higher the credit worthiness of the issuer, the lower the risk will be in terms of debt repayment and, therefore, the lower the interest rate received on your investment. The opposite is also true. The more dubious a company's financial statement, the higher the interest rate the company must pay to attract investors to loan money. With bond investment, the age-old concept holds true: Investors expect higher returns for a willingness to accept higher risks.

Interest Payments
Some types of bonds pay interest on a monthly basis. This interest may be taxable, as with corporate bonds. However, the interest on other bonds, municipal bonds for instance, may be tax free. This encourages investors to invest in projects such as roads, sewage systems, and airports. Still other bonds, such as zero coupon bonds and U.S. Savings bonds, pay no interest until the bonds mature, at which time all accumulated interest is paid.

Rate of Return
Historically, the long term rate of return on bonds is lower than the returns on stocks. Nevertheless, bonds are still appropriate for a portion of an investor's portfolio. Bonds reduce the volatility of a portfolio compared to one allocated 100 percent in equities. The investor's market risk exposure is reduced (compared to stocks). Be aware, however, there is still some risk associated with the various types of bonds.

When Will My Bonds Mature?