Bonds are considered an essential part of a diversified portfolio. They are emphasized as the conservative hedge when the markets go bearish, or for safe, fixed income goals. That said, times have changed. It is unsure whether stocks and bonds are moving in the usual historic opposite directions, as we shift into our second decade of the 21st Century.
First, what are bonds? They are essentially a loan to an entity, such as a business or government, for a fixed rate, for a defined period of time. Corporate, Municipal and Government (ex.: U.S. Treasuries) range in maturity timing from 90 days to 30 years. They are considered fixed income investments.
High-risk, high-income bonds are called junk bonds. And, yes, you can lose money on these. Case in point would be the horrible experiences of the last several years in the mortgage loans and ENRON type scandals. Corporate bonds are the most questionable. Brokers also like to mark up the rates when they sell to you, without calling it a commission on the sale. If in the U.S., and a citizen, you can buy government bonds at a slight discount online or by phone from TreasuryDirect. This service is quite easy to use.
Even government bonds are coming into question these days as national debts are skyrocketing without the old backing of solid gold. One wonders about loaning to those who cannot pay back, and who have huge other amounts of debt. That would be the U.S.A., along with many other countries, like Greece and Italy. There are many varieties of U.S government bonds to choose from, many with tax advantages. That is a pro. The cons remain long-term viability questions and low yields.
Bonds have never been all that exciting, but always considered reliable. The interest paid, especially for short-term bonds, can be far above what a bear market is paying for the average stocks. Times have affected this comparison, however, and the bond market has been languishing for years. A bond fund allows for more diversification, and with municipal bonds, as well as select corporate bonds, a fund can perform admirably.
Lower interest rates on bonds do allow for lower interest rates on mortgages. And some generous souls believe that a loan to the government is a noble pursuit. At the same time, many are becoming disillusioned in lending money to a spendthrift government. It’s all about management. We must get involved in politics and be aware what is happening when we choose either government or corporate bonds. Choose carefully, and hedge your bets with other investments.