Many assets, including individual retirement accounts (IRAs), life insurance policies, and annuities, can have
beneficiaries designated to receive the asset after your death. Make these selections carefully, since they typically override any provisions in your will. Consider the following points:

• Select the most appropriate
  person as beneficiary for each asset. First, list all assets
  with beneficiaries, noting the owner, primary beneficiary, and
  contingent beneficiary. Then determine whether you have selected
  the appropriate person as beneficiary for each asset. In some
  cases, tax and estate planning considerations may help dictate
  whom to select. For instance, spouses typically have more options
  when inheriting an IRA, so that may be the better choice for
  your IRA.
  
  
  
  


• Name contingent beneficiaries. Without a named contingent beneficiary, the asset
  will be included in your probate estate if your primary beneficiary
  dies before you. Then, the asset may have to go through the probate
  process and may be distributed to someone you had not intended
  to receive the asset.
  
  
  
  


• Indicate what percentage
  of the asset each beneficiary should receive. Also,
  in the event a beneficiary dies before you, decide whether each
  beneficiary's share should be distributed to that person's heirs
  or divided among the remaining beneficiaries.
  
  
  
  


• Assess whether beneficiaries
  are capable of managing the asset. If not, you may want
  to set up a trust to control the asset's distribution.
  
  
  
  


• Periodically review
  your beneficiaries to see if changes are warranted. A divorce,
  remarriage, spouse's death, or child's birth are all events that
  may require changes to beneficiaries. You should also review
  your beneficiary choices if you make changes to your will.

Posted by Mike - Editor at 12:25 PM | Permalink

A yield curve is a graph plotting interest rates for the same type of bond for a series of maturities, typically
ranging from three months to over 25 years. Although yield curves can be plotted for any type of bond, they are most commonly seen for Treasury securities.

Bond investors typically use yield curves to help find a maturity that maximizes return at an acceptable
risk level. For instance, you may find increasing a bond's maturity by a couple of years will increase return significantly or committing funds for a long time does not bring much additional return.

Economists study yield curves to help predict inflation, interest rates, and recessions. To do so, you need
to understand what the various shapes in the yield curve indicate about the economy:

• The yield curve's normal shape is upward sloping, since interest rates usually rise as the bond's maturity
  increases. An upward sloping yield curve indicates investors believe the economy is healthy and do not expect interest rates or inflation to increase significantly in the near future. The spread between a three-month Treasury bill and a 25+-year Treasury bond is typically 3% (Source: AAII Journal, May 2003).
  
  
  
  
• A steep upward sloping yield curve indicates
  investors believe the economy will improve quickly in the future
  and is typically seen at the beginning of an economic expansion.
  Short-term rates are typically depressed due to a recent recession.
  Once economic activity starts to pick up and demand for capital
  increases, short-term rates typically increase so the curve becomes
  less steep.
  
  
  
  
• A flat yield curve occurs when short-
  and long-term rates are almost the same. It generally indicates
  that an economic slowdown and lower interest rates will follow.
  
  
  
  
• An inverted yield curve occurs when short-term
  interest rates are higher than long-term rates and is an indicator
  that a recession is likely to follow. An inverted yield curve
  typically means the Federal Reserve is increasing short-term
  rates in an attempt to slow the economy or investors are locking
  in long-term rates in anticipation of an economic downturn.

Posted by Mike - Editor at 12:21 PM | Permalink

Investments in bonds should be tailored
to your investment objectives, risk tolerance, and other personal
circumstances. Answering some fundamental questions will help
you determine the role bonds should have in your portfolio:

What are your overall
investment objectives? Investors committed to growth are looking
for appreciation of capital, with little concern for income, so
bonds will have a minimal role in their portfolios. Total return
investors want a balance of income and capital appreciation, so
bonds will be more important in their portfolios. Income investors
are looking for interest or dividend income, with capital appreciation
a secondary concern, so bonds will have a significant role in
their portfolios.

What's your investment
time frame? When selecting bonds, you should consider when you
need the principal. Typically, yield increases as the maturity
date lengthens, since you assume more risk by holding the bond
for a longer time. Investors are often tempted to purchase bonds
with long maturity dates to lock in higher yields. However, use
that strategy with care. If you purchase a long-term bond and
sell it before maturity, interest rate changes can significantly
affect the bond's market value. Although you can't control interest
rate changes, you can limit the effects of those changes by selecting
bonds with maturity dates close to when you need your principal.

What is your risk tolerance? Typically,
the higher a bond's return, the greater its risk. Thus, U.S. Treasury
securities, which are considered one of the safest bonds, typically
carry lower rates than municipal or corporate bonds. Make sure
you understand the risks involved before purchasing a specific
bond.

Are you concerned with
minimizing income taxes? Interest income from U.S. Treasury securities
is exempt from state and local income taxes, but is subject to
federal income taxes. Interest income from municipal bonds is
exempt from federal income taxes, and typically is exempt from
state and local income taxes for residents in the issuing state.
Interest income from corporate bonds is subject to federal and
state income taxes. Investors in higher tax brackets typically
find tax exemption of interest income more valuable. Be aware
that any exemption from income taxes applies only to interest
income. Capital gains from the sale of a bond are still subject
to income taxes.

What variables should
you consider before purchasing a bond? Before you purchase a specific bond, make sure you fully understand
its features and can answer the following questions:

• What is the bond's maturity?
  
  
  
  


• What is the bond's credit rating and is
  it insured?
  
  
  
  


• Does the bond have call provisions?
  
  
  
  


• What is the coupon rate?
  
  
  
  


• What is the bond's price?
  
  
  
  


• What is the yield to maturity?
  
  
  
  


• How is the bond's interest income taxed?

The role of bonds in your portfolio will
depend on your answers to these questions.

Posted by Mike - Editor at 12:19 PM | Permalink

All investments are subject to risk, although
the types of risk can vary. While you can't totally eliminate
these risks, you can develop strategies to reduce them. For bonds,
consider these strategies:

• Interest rate risk - Interest rates and bond prices move in opposite directions. A bond's price will rise when interest rates fall and decrease when interest rates rise. This occurs because the existing bond's price must change to provide the same return as an equivalent, newly issued bond paying prevailing interest rates. The longer the bond's maturity, the greater the impact of interest rate changes. Also, the effects of interest rate changes tend to be less significant for bonds with higher-coupon interest rates.
  
  

  To reduce this risk, consider holding the
  bond to maturity. This eliminates the impact of interest rate
  changes, since the total principal value will be paid at maturity.
  Thus, selecting a maturity date that coincides with your cash
  needs will help reduce interest rate risk. However, you may still
  receive an interest income stream that is lower than current rates.
  Selecting shorter maturities or using a bond ladder can also help
  with this risk.
  
  
  
  



• Reinvestment risk - You
  typically know what interest income you'll receive from a bond,
  but you must then take the periodic income and reinvest it, usually
  at varying interest rates. Your principal may also mature at a
  time when interest rates are low.
  
  
  

  Staggering maturities over a period of time
  (laddering) can lessen reinvestment risk. Since the bonds in your
  ladder mature every year or so, you reinvest the principal over
  a period of time instead of in one lump sum. You may also want
  to consider zero-coupon bonds, which sell at a deep discount from
  par value. The bond's interest rate is locked in at purchase,
  but no interest is paid until maturity. Thus, you don't have to
  deal with reinvestment risk for interest payments, since you don't
  receive the interest until maturity.
  
  
  
  



• Inflation risk - Since
  bonds typically pay a fixed amount of interest and principal,
  the purchasing power of those payments decreases due to inflation,
  which is a major risk for intermediate- and long-term bonds.
  
  
  
  Investing in short-term bonds reduces inflation's
  impact, since you are frequently reinvesting at prevailing interest
  rates. You can also consider inflation-indexed securities issued
  by the U.S. government, which pay a real rate of return above
  inflation.
  
  
  
  


• Default and credit risk - Default risk is the risk the issuer will not
  be able to pay the interest and/or principal. Credit risk is the
  risk the issuer's credit rating will be downgraded, which would
  probably decrease the bond's value.
  
  
  
  To minimize this risk, consider purchasing
  U.S. government bonds or bonds with investment-grade ratings.
  Continue to monitor the credit ratings of any bonds purchased.
  
  
  
  


• Call risk - Call provisions allow bond issuers to replace
  high-coupon bonds with lower-coupon bonds when interest rates
  decrease. Since call provisions are generally only exercised when
  interest rates decrease, you are forced to reinvest principal
  at lower interest rates.
  
  
  
  U.S. government securities do not have call
  provisions, while most corporate and municipal bonds do. Review
  the call provisions before purchase to select those most favorable
  to you.
  
  
  
  Keep in mind that the assumption of risk
  is generally rewarded with higher return potential. One of the
  safest bond strategies is to only purchase three-month Treasury
  bills, but this typically results in the lowest return. To increase
  your return, decide which risks you are comfortable assuming and
  then implement a corresponding bond strategy.

Posted by Mike - Editor at 11:39 AM | Permalink

With interest rates still at historically
low levels and the economy picking up steam, the Fed has started
to raise interest rates. The question now is by how much and how
quickly the Fed will increase interest rates. The answer is especially
pertinent to bond investors who will find their bond values decreasing
as interest rates increase. But don't totally abandon bonds just
because their values may decrease in the near term. There are
still valid reasons to hold bonds in your portfolio.

• Bonds add diversification
  to your portfolio. Many investors added bonds to their
  portfolios in the aftermath of the recent stock market declines.
  However, all investments move in cycles, with bonds now poised
  to decrease in value when interest rates increase. The whole
  point of diversification is to hold a mix of investments so when
  one investment type is declining, other investments will help
  offset those declines. Historically, stocks and bonds have a
  low positive correlation with each other.
  
  
  
  


• Bonds offer fixed,
  periodic interest payments and your principal's return at maturity.
  Thus,
  even if current bond values decline, you receive some return
  in the form of interest payments and the return of your entire
  principal at maturity.
  
  
  
  


• Bonds are often better
  suited for short- and medium-term financial goals. If you need your
  money in the next few years, you may not want to keep those funds
  invested in stocks, since a major stock decline could occur when
  you need the money

Rather than selling all your bonds, look
for strategies to use in a rising interest rate environment. Some
strategies to consider include:

• Use a bond ladder. A bond ladder is a portfolio of bonds of similar
  amounts maturing in several different years. When one of the
  bonds matures, the principal is reinvested in another bond at
  the bond ladder's longest maturity. By spreading out maturity
  dates, you lessen the impact of interest rate changes. Holding
  the bond until maturity prevents interest rate changes from resulting
  in a loss when you sell the bond. Since your bonds mature every
  year or so, your principal is reinvested over a period of time
  instead of in one lump sum. If interest rates rise, you have
  principal maturing every year or so to reinvest at higher rates.
  In a declining interest rate environment, you have some funds
  in longer-term bonds with higher interest rates. But the main
  advantage is you don't continue to hold only short-term bonds
  while you wait for interest rates to peak, an event that is difficult
  to predict.
  
  
  
  


• Consider a bond swap. A bond swap is simply the sale of one bond and
  the purchase of another. A rate anticipation swap is made to
  take advantage of changes in market interest rates. It typically
  involves swapping short- for long-term bonds or vice versa, depending
  on your beliefs about the future direction of interest rates.
  When you anticipate interest rates might increase, you might
  swap out of longer-term bonds into short-term bonds. Then, when
  interest rates do increase, you will have funds available to
  invest at the higher rates. Before executing a rate anticipation
  swap, make sure you understand all costs that will be incurred
  and whether the sale of your existing bond will result in a taxable
  gain or loss.
  
  
  
  


• Invest in short- or
  intermediate-term bonds. When interest rates rise, bond values
  decrease the most for long-term bonds, since they have a long
  stream of interest payments that do not match current interest
  rates. Thus, for new bond purchases, you may want to shorten
  your maturity dates in the near term until rates stabilize at
  higher levels.
  
  
  
  


• Compare all types of
  bonds before investing. If you have a bond maturing, don't
  just reinvest in the same type of bond without taking a look
  at other alternatives. For example, lately the spread between
  corporate and municipal bonds is very small, making municipal
  bonds an attractive alternative for investors in higher tax brackets.

Posted by Mike - Editor at 11:37 AM | Permalink