Business & Finance Tips

For most investors, bonds are just one thing – ballast. Bonds can work well for income seekers, and, in the hands of an adept speculator, they can beat the stock market for long stretches. But this is not how most investors use them. Most buy and hold, rather than speculating.

There is a better way to get extra value from your bond investment. Bonds help in keeping a stock-focused portfolio sturdy — steadily, predictably heading in the right direction for long-term returns.

It’s All About The Ratio

The first fixed-income question for most investors is, what’s the right ratio of bonds to stocks?

Michael Holland, manager of the Holland Balanced Fund, strongly advocates a 60/40 ratio of stocks to bond for most investors. With this ratio, investors can generally gain 80% of the stock market’s long-run return but with only a moderate level of volatility along the way.

Interested in even more security than that? The minimum-risk allocation is probably 80% fixed-income, 20% stock, according to Alan Gayle, senior investment strategist for Trusco Capital Management. In his view, a 100% bond allocation is never a good idea, even for the most risk-averse investor, because bonds can suffer lengthy bear markets in their own right.

Whatever your asset-allocation goal, you should always be splitting up the bond portion of your portfolio between the different classes of bonds.

* Start with at least 25% invested in bonds with as little default risk as possible – this means Treasuries, inflation-indexed Treasuries or municipal bonds.

* Add an allocation of up to 65% for bond funds with “economic exposure,” such as those focused on highly rated corporate bonds. These usually outperform Treasuries when the economy heats up. A fund is a better choice than direct investment for most investors because it offers a level of diversification few investors achieve with individual corporate bonds.

* Don’t neglect junk bonds. They deserve at least 10% of your bond investment. High yield bonds correlate more closely with equities than with fixed income investments, and their higher yields can compensate when Treasury yields are low. Don’t buy direct – funds are the only safe way to play the high-yield market.

Lowest Risk Bond Type – Treasury Bonds

The safest choice of bond investment for your portfolio is Treasuries (and inflation-protected Treasuries). Only rarely do Treasuries offer the fixed-income world excitingly large returns. But their issuer — the US government — won’t be going bankrupt any time soon. In troubled times, that is an important consideration.

Bond Investing – Why Buy Into A Fund?

The primary advantage of these funds is that they simplify your investment. Writing a check to a fund company takes less effort than buying individual bonds and can, for some investors, be worth a small annual fee.

Many financial planners criticise government-bond funds, though, because few bond funds feature a single maturity date. Most managers buy and sell to take profits or pounce on perceived bargains. This means that there is no way to guarantee the return of your capital in full on any precise date – one of the key reasons for buying bonds in the first place.

The only way to totally guarantee stability of principal is to buy individual bonds at issue and hold them to maturity.