A bond is a fixed-debt instrument used by corporations and governments to finance projects or operations. In other words, a bond is a loan from you to a corporation or government.
What does that mean?
Let’s imagine this was a traditional loan between two individuals, you give the other individual $100,000 and they agree to pay you back in 30 years at a specified interest rate. You can verify credit for a company just like you can for an individual. The worse the credit rating for the company, generally the higher interest rate you will receive. You have to keep in mind, as interest rates rise and fall, it can affect how valuable your bond is.
Can my bond lose value?
Imagine purchasing a $100,000 bond from a company with 30 years timeframe at 3% interest. Next year, rates rise, so now that same company is offering new bonds for 30 years at 5%. You may have to sell your bond at a discount in order to entice potential buyers.
Are bonds safer than stock?
Technically no, if a company goes out of business, you’re more likely to get your money back but it’s not guaranteed, not at all. You can lose money with a bond as well, just at a slower rate.
Bonds move at a slower pace, so you’re more likely to see some of the downturns of a company over a longer period of time, as with a stock, it could happen overnight.
How does this affect me?
Today, most investors purchase bonds through mutual funds, which greatly helps with liquidity and bond interest rate regularity, but bonds in a mutual fund can still lose value just as an individual bond purchased directly from a company or government.
Should I “buy bonds to match my age”?
Some investment advisors believe you should have a percentage of bonds equal to your age. For example, they may think if you’re 55 years old, you need 55% of bonds in your portfolio. I wholeheartedly disagree with that belief for two reasons.
- Your portfolio allocation, including your bonds, should be specific to your individual needs, risk factors, goals and comfort level with investments.
- That belief is a blanket recommendation, industry jargon for “cookie-cutter”, and a bit lazy.
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