Bond Investing Info
For many investors, bonds are a core element of a financial plan to invest and grow wealth. Financial advisors often recommend that investors maintain a diversified investment portfolio rather than sinking all of their investments into one place. A diverse portfolio often contains bonds, stocks, and cash in varying percentages, ultimately depending on the circumstances, goals and objectives of the individual investor.
What Are Bonds?
A bond is what is known as a debt security, similar to an I.O.U. As an investor, when you purchase a bond then you’re lending money to the issuer of the bond. This can be the federal government, a municipality, mortgage or asset-backed securities, corporate bonds, foreign government bonds, and other types of bonds available for investment. They are also referred to as bills, notes, debt securities or debt obligations.
Why Invest in Bonds
Many investors choose bonds because they provide a predictable income stream, as well as a means to preserve capital investment. Because bonds pay interest semiannually and take time to mature for a return on the principle, they are commonly chosen in the creation of a diversified portfolio for retirement investors.
All investments carry a certain degree of risk linked to the overall return on that investment. For investors, a common rule of thumb is that when the risk is high, so is the return. Where bond investment is concerned, there are a number of factors affecting risk including the price, interest rate, yield, maturity, redemption features, tax status, credit rating and default history. These factors help investors determine the overall risk of bond investing
The Price of Bond Investing
The prices on a bond are based on a number of variables including interest rates, credit quality, liquidity and supply and demand. Newly issued bonds tend to sell close to the face or principal value while bonds traded on the secondary market fluctuate in price as they response to changing interest rates, economicconditions, supply and demand, and credit quality. When bonds sell above their face value they’re known as selling at “premium”. When selling below their face value they are sold at “discount”.
Interest Rates on Bond Investing
Bonds pay out interest in a number of ways; fixed, floating or payable at maturity. Most bonds carry fixed interest rates until maturity, where the interest is a percentage of the face amount. That interest rate is established when the bond is issues.
Floating rates on bonds reset periodically in line with interest rates on Treasury bills, the London Interbank Offered Rate (LIBOR) or another benchmark index for interest rates. With the “payable at maturity” interest, there is no period payment on the bond. Instead the principal is repaid on maturity along with total interest earned, which is compounded at the original interest rate.
Maturation of Bonds
A bond’s maturity refers to the length of time before the principal is repaid to the investor. In most cases, bond maturity can range from a single year to thirty years, with time of maturity broken into three ranges.
- Short Term – Maturity occurs within 5 years
- Medium Term – Maturity occurs between 5 and 12 years
- Long Term – Maturity is greater than 12 years
Term choice ultimately depends on your preference as an investor. Short term bonds are safer and offer lower returns while long term bond investments have a greater return while experience more price fluctuations as well as market risks.
This information is for educational purposes only and in no way guarantees your profitability by trading the equities mentioned. See Terms and Conditions.