Having Bonds in Your Investment Portfolio

Bonds are loans. These loans are given by individuals like you and I to big organizations, national/federal governments, even specific cities like Lagos.

There are so many investment securities to have in your investment portfolio beyond stocks, and a bond is one of them. Bonds are loans. These loans are given by individuals like you and I to big organizations, national/federal governments, even specific cities like Lagos.

As you would expect, these companies or governments borrow from multiple sources like a form of crowd funding. To correctly understand how a bond is different from a stock, think of a bond as one part of a huge loan, and stocks as one part of a huge ownership.

This simple difference will also explain their place in earnings and their volatility levels.

Risk

Bonds are amazing for income investors. A key reason for this is that the volatility of bonds is much less than stocks. In other words, they generally fluctuate much less.

An upside to the risk element of bonds is that in the event of the bankruptcy of a company, you have the upper end in terms of getting your money back than a stock investor or an owner of the company.

Be that as it may, there is still the risk of companies – big as they are – defaulting on bonds.

Profit

The earnings from bonds are limited. As such, if you depend on them for growth, you will be on a very counterproductive journey. Just like stocks, bonds make their money in two core ways.

The first is through the interest received which is alongside the fact that if all things go as they should, you will receive your principal back at maturity. The second also just like stocks is that you can also sell your bond at a higher price than you got it for gains.

Yet, the profitability of bonds is inherently limited. Bonds pay out a much lower return on your investment than stocks would. Sometimes, you might not even earn enough to beat inflation.

Using Bonds To Balance Your Income Portfolio

That said, there are situations where you want your portfolio to not only be spread across different classes for the benefits of diversification, you also want to yield a level of income. There are ways to mitigate some limitations of bonds.

The first thing is to know the percentage of bonds to have in your portfolio especially towards building up for retirement. One timeless rule for determining the percentage of your investment goes to bonds is that of your age.

The idea is that if you are 25, 25% should be in bonds. If you are 40, 40% of your portfolio should be in bonds and if you are 70, 7% should be in bonds. The clear idea behind this is that when you are younger, you should generally be able to take more risks like investing in stocks for growth.

However, when you are older, you need a level of security and safety for your investment.

Other ways to mitigate possible limitations of bonds is to opt for bonds that have tax advantages such as municipal bonds or bond funds which are pretty much like mutual funds for bonds.

Also avoid bonds that you have to hold on for too long (say more than 7 years) as their value could crash because of inflation and fast-moving interest rates. Finally, unless you know exactly how foreign exchange works, you might want to avoid foreign bonds.

With these in place, you can invest in bonds as a good tool to augment your stock investments.

Written by Lawretta Egba.