Bonds: Why invest in
bonds?
Bonds can provide a
worry-free stream of income. But this class of securities includes a wide array
of instruments with varying degrees of risk and reward, some of which offer
gains -- or losses -- comparable to those of any stock. Used improperly, bonds
can really mess up your financial life. Handled with care, however, bonds are
among the most valuable tools in your investment kit. Here are some of the
benefits bonds can provide:
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Diversification -
It is true that stocks have posted compound annual returns of around 11 percent
for the past two centuries, versus 5.1 percent for long-term U.S. government
bonds. But while stocks have returned more than bonds over most of this decade,
they are also more volatile. Combining stocks with bonds will net you a more
stable portfolio, helping you sleep better at night. Many personal financial
advisors recommend that you maintain a diversified investment portfolio
consisting of bonds, stocks and cash in varying percentages (diversification),
depending upon your circumstances and objectives.
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Income - Because
bonds typically have a predictable stream of payments and repayment of
principal, many invest in them to preserve and increase their capital or to
receive steady stream of interest income -- such as retirees -- who desire a
steady stream of income.
-
Security - Next to
cash, U.S. Treasuries are the safest, most liquid investments on the planet.
Short-term bonds are a good place to park an emergency fund or money you'll need
relatively soon -- say to buy a house or send a child to college.
-
Tax savings -
Certain bonds provide tax-free income. Although these bonds usually pay lower
yields than comparable taxable bonds, investors in high tax brackets (generally,
28 percent and above) can often earn higher after-tax returns from tax-free
bonds.
As most investment advisors will
tell you, some portion of your portfolio should be in bonds. Investing in bonds
generally provide a high degree of safety with regular, predictable, scheduled
payments over the life of the security.
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Why is the interest on
the bond called coupon?
Originally, bonds were issued with
detachable coupons, which you clipped and presented to the issuer or the
issuer's agent — typically a bank or brokerage firm — to collect your
interest payment. They're also known as bearer bonds because the bearer of
the coupon is entitled to the interest.
Although most new bonds are electronically registered rather than issued
in certificate form, the term coupon has stuck as a synonym for interest
in phrases like the coupon rate. When interest accumulates rather than
being paid during the bond's term, the bond is known as a zero coupon. |
Next==>> Key things to
consider before buying bonds
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