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A key part of your investment strategy for wealth creation should include bonds as investments. When the topic of investing money is thrown around for discussion, the phrase "stocks and bonds" tends to be used quite commonly. While most people tend to gravitate toward investing money in stocks because of their upward potential in value appreciation, bonds are also a great way to invest money for anyone looking for more income.
Historically stocks have outperformed bonds. But on average, bonds as investments have also historically provided very decent returns. Additionally, investment portfolios that have included both stocks and bonds have provided higher returns than bonds alone. According to Forbes, the performance of stocks have averaged returns of about 10% annually since the Great Depression in the 1930s. That compares to average returns of bonds as investments of about 6% since the same period. On top of that, a balanced portfolio that includes both stocks and bonds, generally allocated as 60% in stocks and 40% in bonds, has generated about 8.5% in annual returns. The two working together are an excellent wealth creation system.
Why Invest in Bonds
Bonds provide a great source of investment returns while also affording excellent diversification to your portfolio. Give significant consideration as a part of your strategy for wealth creation. While stocks have outperformed bonds on average over the long-term, there are definitely periods in which bonds have held their own compared to stocks. The performance of bonds as investments tends to ebb and flow with the performance of stocks. So, when stocks are doing poorly during bear markets marked by high inflation and high interest rates, bonds tend to perform well. Having bonds as a part of your portfolio helps to balance out the ups and downs of stock market performance.
To that end, bonds provide a certain stability to the investment portfolio. They're far more stable than stocks and are one of the best ways to invest money. Up to a point, bonds will have a much greater impact on lowering risk than they will on return. It's not the case that bonds as investments are appealing because of the potential for high returns, but rather for the stability and current income they bring to the investment portfolio.
Individual Bonds vs Bond Funds
If you want to add bonds to your investment strategy, you can either buy directly into individual bonds, or you can invest in bond mutual funds. As with most everything, there are pros and cons associated with both approaches.
Buying directly into individual bonds is less costly than investing in bond mutual funds and doing so affords control over your investment portfolio. But it is not always simple to do, and it's really not advisable for the novice investor. If choosing to invest directly in bonds, however, it's better to take a passive approach focused on the fixed-income that bonds provide. Try to lock in prevailing high yields, especially if it is believed that interest rates have nearly peaked. Bonds that provide some sort of call protection are also best, so you can hold on to that income for the long-term till maturity.
In contrast, directly investing in bonds with an aggressive approach means focusing on potential price appreciation. This is much more involved and not for the faint of heart. You'll need to closely monitor the movement of interest rates, yield spreads, and other economic conditions like inflation which can erode returns over the life of the bond. Investing directly in bonds also requires a lot more of an understanding of bonds' features, such as call options. Whether taking a passive or aggressive approach, investing directly in bonds requires a lot more effort and understanding. There's a lot of information to sift through on an ongoing basis, which can be difficult to do.
With a bond fund, you let a professional manager deal with these issues. It'll cost a bit more, but you minimize your risk and the cost of time by allowing someone else to do the heavy lifting for you. As a result, monitoring your portfolio will be easier, but be sure to analyze total returns and not just yields.
Unlike individual bonds, however, there's no guarantee of a fixed interest rate, since bond fund returns are driven by market interest rate trends. They also tend to be more volatile since the manager is likely buying and selling bonds as he/she sees fit rather than holding them to maturity. However, identifying a solid bond fund administered by a fund manager with a solid track record can prove to be a key part of your portfolio. In evaluating a bond fund, look at both short-term and long-term returns and a manager who has a solid, long-term track record. And to minimize cost, seek out a fund with an expense ratio of 80 basis points or lower.
Also, be sure to have a clear understanding of any bond fund's objectives and policies before investing. Have an understanding of exactly what securities are in the fund, and check the current maturity length and current duration. If "income" and safety of principal are your primary objectives, don't buy the longest-term funds or those with the highest yields which are going to be most risky. Instead, stick to funds with intermediate maturities and invest in high-quality bonds.
Adding bonds to your investment strategy can provide significant advantages relative to wealth creation. Doing so can afford excellent diversification, portfolio stability, and competitive returns. To add bonds as investments to your portfolio, you can generally do so by either investing directly into bonds or investing in a bond mutual fund. Direct investment will surely be more time-consuming and should generally be done by investors well-versed in economics and bond investing. In contrast, investing in a bond fund will carry ongoing fees, but doing so affords professional fund management and an easier time monitoring your portfolio. It all boils down to individual need and risk-tolerance!
The information provided on this site is based on my own personal experience, research, and analysis, and it is not to be construed as professional advice. Please conduct your own research before making any investment decisions. I am not a professional financial advisor, stockbroker, or planner, nor am I a CPA or a CFP. The contents of this site and the resources provided are for informational and entertainment purposes only and do not constitute financial, accounting, or legal advice. The author is not liable for any losses or damages related to actions or failure to act related to the content on this website.