If you’re interested in generating an income stream from your investment portfolio, bonds can help fulfill that role. They can also help diversify* a portfolio since the prices of bonds and stocks don’t always move in the same direction. Following is an overview of some bond investment strategies that are available if you choose to invest in bonds.
Buy and Hold
One of the primary risks of investing in bonds is interest rate risk. This is the possibility that a change in interest rates will affect the value of a bond investment. When interest rates rise, the prices of existing fixed-rate bonds fall (and vice versa). Investors are less attracted to the interest rates of previously issued bonds than to the higher rates of newly issued bonds of similar quality.
But by using a buy and hold strategy, changes in the value of the bond shouldn’t affect you since you’re committed to owning the bond until maturity. If the bond doesn’t default, you’ll receive interest payments and the face value of the bond at maturity.
Another way of managing interest rate risk is by laddering your bonds. This means you invest in multiple bonds that mature at different times. When one bond matures, you reinvest the proceeds to purchase another bond with the longest maturity on your ladder. If interest rates have gone up, this gives you the opportunity to earn a higher rate on your new bond. If they’ve fallen, you still have other bonds earning rates above the current market rates.
Another way to help manage interest rate changes is with a barbell strategy. This approach involves purchasing only short- and long-term bonds. The longer term bonds allow you to lock in higher rates. As the short-term bonds mature, you have the ability to invest in other types of assets (or long-term bonds) if rates have declined. If interest rates are rising, then you can reinvest in other bonds at the higher prevailing rates.
Pursuing a bullet strategy means purchasing several bonds with maturity dates around the time you’ll need the money to pay for a specific goal, such as college tuition. Buying the bonds at different times and in different interest rate environments may help you manage interest rate risk.
Bonds may add some stability to your portfolio as they tend to be less volatile than stocks. It’s possible bonds may perform well when stocks decline, and vice versa. The investment performances of stocks and bonds react differently to fluctuations in interest rates and economic conditions. By including both stock and bond investments in your portfolio, losses in one asset class may be offset by gains in the other type. When you’re concerned about your portfolio’s exposure to risk, including bonds can help you diversify your investments.
* Diversification does not ensure a profit or protect against loss in a declining market.Back to Articles