A Quick Q and A on Bonds
Today, I’m going to answer a couple of questions from “Diane” in Palm Coast. Diane sent me several questions on rising interest rates, stocks and bonds, but in this column we’ll just tackle bonds.
“When would it be advisable to get into the bond sector – now (before prices escalate)?”
Bonds are a type of security. They are a form of debt typically issued by a company or a governmental entity. They are not a “sector.” Economic sectors include health care, financial services, technology, energy, etc. Bond prices are affected by many factors, just like stocks. When interest rates go up, existing bonds tend to go down in value. Bond prices might go up if there is a big spike in demand because of investors pulling out of stocks. Also, it’s important to note that stocks and bonds tend to move somewhat independently of each other, which is why you might see both of them in a “balanced portfolio.” However, keep in mind, there are times when stocks and bonds will both go down.
“Should I go directly into treasuries, or corporate and/or municipal bonds? What do you recommend – long or short periods?”
To get an adequately diversified portfolio with individual bonds, you’d need to have a lot of money to invest. However, buying just one bond mutual fund could give you ownership in hundreds of individual bonds. There are plenty of bond mutual funds you can buy for less than $1,000.
Treasury, corporate, and municipal bonds (also called munis) may each have their place in a diversified bond portfolio. Of the three, corporate bonds tend to have a higher interest rate. Treasury bonds are probably perceived as the least risky. And municipal bonds can offer tax advantages, especially for those taxpayers in the highest income tax brackets. As far as “short” or “long” periods, I would suggest a mix of maturities, as well. Shorter-term bonds (5 years or less to maturity) usually don’t earn as much interest as long-term bonds (10 years or more to maturity); however, the longer the bonds, the more sensitive they will be to interest rate changes. If interest rates go up, the market value of a longer bond will fall more than a shorter bond. Thanks for the great questions, Diane!