Keep These Bond Tips in Mind
Interest in bonds has grown due to declines in the stock market, but the current low interest rate environment means investors need to carefully devise investment strategies for bonds. Consider the following tips if bonds are part of your investment portfolio:
- Follow interest rate trends. At a minimum, follow the prime rate, Treasury bill rates, and Treasury bond rates. Understand the significance of the yield curve and follow its pattern over time. A knowledge of current interest rate levels can help you evaluate the appropriateness of a specific bond's interest rate.
- Carefully choose maturity dates for bonds. The date you need your principal is an important factor, but other factors should also be considered. For instance, bonds with longer maturities are more significantly impacted by interest rate changes. So in volatile environments, you might want to shorten maturities. Reviewing the yield curve might suggest that a slightly longer or shorter maturity is more appropriate. Rather than investing in one maturity, you may want to stagger or ladder the maturity dates, purchasing short-, intermediate-, and long-term bonds.
- Understand specific bond risks. The most significant risk is interest rate risk. When interest rates rise, bond values fall, while values rise when interest rates decline. Other risks include default risk, or the possibility the issuer will default on the payment of interest and/or principal; call risk, or the possibility the issuer will redeem the bond before maturity; and inflation risk, or the possibility high inflation will outpace the bond's return.
- Diversify your bond holdings among different bond types. You should consider government, corporate, and municipal bonds as well as different industries, credit ratings, and maturities. There are a wide variety of bonds, so make sure to select ones you are comfortable owning.
- Understand the bond's terms before purchase. Make sure to review the credit quality, coupon rate, call provisions, and other significant factors.
- Compare interest rates for specific bonds before investing. Interest rates can vary significantly between different types of bonds and between bonds with different maturities.
- Consider the tax aspects of different bonds. By carefully comparing the after-tax rate of return for various bonds, you may be able to increase your return. Depending on the type of bond, interest income may be fully taxable or exempt from federal and/or state taxes.
- Review your bond holdings periodically. Review the credit ratings of all your bonds at least annually to ensure the quality hasn't deteriorated. Make sure your holdings are still consistent with your overall investment objectives.
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