If you’ve ever wondered what bonds actually are, how they work, and whether or not they’re a good investment choice for you, today’s blog will give you the Top 9 things you need to know so that you can make an educated choice. Enjoy.

#1) Bonds are issued by large companies and oftentimes the government

Large companies, the federal government and state governments issue bonds as a way to raise money to fund or finance a specific project. Basically what you’re doing is loaning them your money for a specific period of time and, in return, you get the loan back plus interest.

#2) In terms of performance, Bonds often outperform Stocks

Yes, during some periods of time in the last 150 years or so, stocks have done much better than bonds. On the whole however, returns on both have been about the same and, starting in 2003, the bond market has outpaced the stock market quite handily.

#3) A return on bonds is not guaranteed

Although the interest payments on bonds is fixed, their returns aren’t. If the company that issued the bonds goes bankrupt, you could lose your investment. Luckily this doesn’t happen very often.

#4) Bonds and interest rates usually move in opposite directions

Interestingly, bond prices usually rise when interest rates fall, and vice versa. These fluctuations don’t matter if you hold a bond to maturity however, as you will get back not only the original face value of the bond when you purchased it but the interest you expected as well.

#5) There’s a big difference between bonds and bond mutual funds

When you purchase a bond you’re guaranteed to get your principal and interest when it matures . (Assuming the company that issued the bond, or the government, doesn’t go bankrupt. See #3 above.)   The value of bond mutual fund fluctuates however, meaning that your return is uncertain.

#6) It’s unwise to invest all of your retirement money into bonds

Over time, the value of your bond’s fixed interest payments will be eroded by inflation. Even though stocks sometimes get hammered, in the long run they have a much better chance of outpacing inflation, thus younger and middle-aged people should put a good bit of their retirement money into stocks as well. As people are living longer lives these days, it’s even a good idea for retirees to own some stocks.

#7) Don’t forget to consider tax-exempt municipal bonds

Even though they might yield less than taxable bonds, tax-exempt municipal bonds can net you more income if you’re in the 28% federal tax bracket or higher.

#8) Yield is important, but still pay attention to total return

In the bond world, returns can be a little bit tricky. For example, if a broker sells you a bond that’s paying an interest rate of 6%, but interest rates rise and the price of the bond goes down by 2%, your total return for the year would only be 4% (6% and income minus 2% in capital loss).

#9) For steady income it’s best to purchase short and medium-term bonds

Your best bet for steady income from bonds is to invest in what the experts call a “laddered portfolio” of both short and intermediate term bonds.  If you aren’t sure what that is, talk to your financial expert to find out, or Google “laddered portfolios”.

Filed under: BondsInvesting

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