A strong portfolio is one that is well-diversified. Bonds, while inherently lower-risk and lower-yield, provide a balance against higher-risk, higher-yield instruments such as equities.
Bonds are debt securities. When the Government and corporations need to take out loans to fund projects, they issue bonds which promise to pay lenders back in a fixed number of years on the bond’s maturity date with interest payments along the way. The biggest draw of corporate bonds is that they pay out highest interest rate among bonds. Note: zero-coupon bonds do not pay interest until maturity date.
3 key benefits:
Generally safe investment. While all investments carry risk, it is very unlikely for the Government to default and uncommon for high-quality corporate bond to default.
Steady stream of income. Bonds offer some regularity to your income stream, because you can typically count on interest payments twice a year. This makes budgeting somewhat easier.
Easy to Manage. Unlike equities, there is no need to constantly worry about when to buy or sell in the market. You can earn a regular income just by buying once and holding till maturity, though some investors do sell at a profit before maturity date.
3 key drawbacks
Low yield. Bonds add stability to your portfolio by balancing out higher-risk investment instruments. Compared to the latter, with lower risk comes lower rewards.
Locked-up funds for pre-determined period. Bonds require long-term commitment, till maturity to obtain the full rewards of investment. It has lower liquidity as compared to savings accounts or equities.
Risk is still involved. Bonds still carry some risk, though proportionately small compared to higher-risk investment instruments. The worst case scenario is for a bond issuer to default, meaning you might not earn interest or lose your principal investment, or both.
Individual Bonds versus Bond ETFs
Bond ETFs are an alternative to purchasing individual bonds. It is a basket of bonds, so if one of the bonds defaults, other bonds in the same basket protect your investment. You will need to thoroughly research issuers for various individual bonds purchasing.
Bonds will play an important role in your portfolio, thus it is essential to get the right balance for your portfolio.
Are you vested in bonds as well?
Theory of Constraints 