En español | If you pay attention to the news from financial markets these days, you know that prices of bonds have been headed down. Nonetheless, most financial professionals agree that every investment portfolio should have some bonds as part of a diversification strategy.
See also: 5 common money mistakes.
So here are 10 things you should know about investing in bonds.
1. Just what is a bond?
In its simplest form, it's a pledge — you lend money to an issuer in return for a promise of interest payments and return of the full amount at the end of a fixed term. Unlike with a share of stock, you are not buying ownership; you're just lending your money. You can hang on to a bond until maturity, or you may be able to sell it in a financial market to someone else who will then collect the interest and get the principal payment at maturity.
2. Why invest in bonds?
"Bonds offer protection against stock market swings," says Mike Ruff, fixed income portfolio manager at Seattle-based Russell Investments. Their returns come mainly in the form of interest payments, which can be counted on even in turbulent times when asset values are tumbling.
3. Who issues bonds, and how do bonds differ?
Bonds are issued by the federal government, states, municipalities, corporations, foreign governments and more. "Some bonds pay higher interest than others," says Michael Sullivan of the Estate Planners Group in Washington Crossing, Pa. "Some offer interest that's free from federal and state tax."
4. How can I buy bonds?
You can buy individual bonds or bond mutual funds through stockbrokers. "A diversified, carefully managed mix of individual bonds will often perform better than buying a mutual fund," says Sullivan. But he cautions that putting together such a portfolio requires significant personal expertise or expert help.
5. Are bonds risk-free?
No form of investment is entirely free of risk. The market value of your bond can fluctuate — when interest rates go up, bond prices typically come down. There's credit risk in whether the issuer will be stable enough to be able to pay interest and principal. And there's liquidity risk — will you be able to sell your bond when you need to?
6. How about federal government bonds?
Known in the investment community as "Treasuries," these bonds are protected against default (but not price fluctuations due to interest rate changes) by the full faith and credit of the U.S. government. You can purchase Treasuries for a fee through a stockbroker or direct from the U.S. Treasury with no fee. For more information, go to TreasuryDirect.