Why own bonds at all

What are bonds? How to buy and sell bonds Understanding fees Avoiding fraud Additional information Why do people buy bonds? Investors buy bonds because: They provide a predictable income stream. Typically, bonds pay interest twice a year. If the bonds are held to maturity, bondholders get back the entire principal, so bonds are a way to preserve capital while investing. Bonds can help offset exposure to more volatile stock holdings.

Companies, governments and municipalities issue bonds to get money for various things, which may include: Providing operating cash flow Financing debt Funding capital investments in schools, highways, hospitals, and other projects What types of bonds are there? There are three main types of bonds: Corporate bonds are debt securities issued by private and public corporations. These bonds have a higher credit rating, implying less credit risk, than high-yield corporate bonds.

These bonds have a lower credit rating, implying higher credit risk, than investment-grade bonds and, therefore, offer higher interest rates in return for the increased risk. Revenue bonds. Instead of taxes, these bonds are backed by revenues from a specific project or source, such as highway tolls or lease fees. Conduit bonds. Governments sometimes issue municipal bonds on behalf of private entities such as non-profit colleges or hospitals.

If the conduit borrower fails to make a payment, the issuer usually is not required to pay the bondholders. Treasuries are issued by the U. The owner of the year bond is still stuck with lower payments for decades and thus would get a depressed value if sold. Another common way to get more yield is to buy bonds from issuers with lower credit ratings. Caution is warranted here too. If you want stability for some portion of your portfolio, a diversified array of good quality bonds with a reasonable duration, can achieve that goal.

However, if you are looking at bonds for higher interest payments, you must be willing to take on more risk of loss. If you are looking for long term growth, diversified stocks have been a better choice. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some questions are edited for brevity. By controlling portfolio losses in adverse equity markets and ensuring liquidity is available for cash needs, an allocation to bonds can create peace of mind and avoid irrational, emotional decision making in times of crisis.

While Treasuries are not a perfect hedge, during most sharp equity corrections in the last 20 years, U. Treasuries have rarely declined and have often appreciated materially. Treasury yields rarely increase sharply, which lowers the cost to investors for owning these assets in their portfolios.

We also believe that Treasury yields are unlikely to increase materially during an equity sell-off, which means government bonds should continue to act as a hedge during market turmoil. Second, Treasury bonds can be converted to cash to meet liquidity needs. As we experienced in March, sometimes pricing may be adversely affected in a crisis, but the impact of these price concessions was considerably lower than the impact of selling other risky assets. Third, there are many other types of bonds that have higher yields than Treasuries and can be used to generate income in a low-rate environment.

In order to earn a higher yield, investors will take on different risks, including liquidity risk or credit risk. We recommend discussing the potential downside of these bonds with a financial professional before considering these securities in a portfolio. The size of your total fixed-income allocation will vary depending on your individual risk tolerance, liquidity needs, income needs, liabilities, objectives and assets that you hold outside of your liquid investments.

Most of these items should be included in your investment policy statement and reviewed at least annually. For business owners, we account for their businesses in their overall asset allocation. This exercise includes assessing profitability, reviewing the capitalization of the business and reviewing current credit agreements. More importantly, if the operating business is cyclical, leveraged or growing rapidly, we encourage owners to consider potential liquidity needs under more draconian assumptions and recommend a larger allocation to fixed income.

Earlier this year, we learned how difficult it may be to access cash, so planning ahead can prevent the need to sell depreciated assets for liquidity. For foundations committed to maintaining their spending policy, liquidity is also paramount.

We recommend having two years of operating and funding requirements available in conservative fixed-income strategies. This will ensure your foundation can meet its commitments to its grantees and continue operations without disruption. Stocks have returned far more than bonds over the long run. So, why own bonds at all? Bonds or bond funds can serve two valuable roles in your portfolio:.

You can determine a fund's bond holdings from its style box. Bonds are usually less volatile than stocks, but they are not risk free. There are two major risks:. One way to minimize credit risk is to invest in bonds issued by the U. Treasury or by federal agencies whose debt is backed by the full faith and credit of the United States government. Keep in mind, though, that Treasury bonds generally pay lower interest rates than other bonds of the same maturity. Corporate bonds, which are also worth considering, are rated by credit-worthiness.