Understanding Bond Investing: It’s a Matter of Balance
It’s a common misconception to think of bonds as “plain vanilla” investments that are appropriate only for certain types of people, such as financially conservative retirees. But in reality, bond investments may have the potential to add stability to a portfolio and help reduce overall investment risk — regardless of your age or financial outlook.
What Is a Bond?
Bonds are investment securities issued by corporations or governments to raise money for a particular purpose. Basically, bonds are the “IOUs” of the business world. There are different types of bond funds, each with varying levels of risk and return potential. Generally speaking, the higher the risk, the better the return potential. For example:
- Government bond funds invest in bonds issued by the U.S. Treasury. Historically, they have been among the strongest types of bond investments. However, they typically offer lower returns than other bonds.
- Corporate bond funds invest in bonds issued by private companies. They can range from “investment grade” (safer, lower return potential) to “below investment grade” (riskier, higher return potential).
Know the Risks
Bond funds are subject to several types of investment risk, including:
- Market risk — Like stock prices, bond prices move up and down. However, such fluctuations tend to be less severe in the bond market.
- Interest rate risk — When interest rates rise, bond prices may fall, and vice versa.
- Inflation risk — If the return on a bond fund does not outpace the rising cost of living, the purchasing power of your investment could decline over time.
Despite these risks, investors of all ages may potentially benefit from putting some money in bond funds. Because bond funds tend to respond to market influences differently than stock funds, they may help balance out the risks associated with stock investing.
In addition, lower-risk bond funds, such as government and investment-grade corporate bond funds, may help protect some of your money from losses during turbulent times.
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