There are many factors you have to take into consideration while planning bond investment strategies. Do you want to invest for the long term or short term? What are your investment goals and their time frames? How much risk are you willing to take? What is your tax status? The answers to these questions play a vital role in your investment strategy.
Making The Right Investment Choices
Diversification is one of the most important cornerstones of any strategy. You should make a portfolio of several types of bonds that have different features. This will help to protect you from losses in any particular market. You can manage your interest rate risk by selecting bonds that have different maturity periods.
If you want to earn interest and keep your principal intact at the same time, then you should follow the “buy and hold” strategy. If you hold a bond till maturity, you will get interest on it twice a year. Remember that if you buy a bond while it is at its premium price, the amount you will get at maturity will be less than what you paid for.
Following the “buy and hold” strategy means you won’t be affected by rise and fall in interest rates. It also means that you will not be able to invest the principal at higher market rates. If the bond you choose is ‘callable’, then the principal might be returned to you before maturity. This usually happens when interest rates fall. In such cases, you have to invest your redeemed principal at current lower rates.
If you want to buy and hold bonds, there are a few considerations to bear in mind. Firstly, you should know the coupon interest rate of the bond. Secondly, you need to know the yield to maturity - the higher the yield, the higher the risk. Thirdly, look out for the quality of credit of the issuer. Bonds from lower credit rating issuers might offer higher yields, but promises made by them might not be kept.
If you want maximum interest income, then corporate bonds are a viable option. High yield bonds, also known as junk bonds, have low credit ratings but high yields. Again the problem here is that an issuer may default on interest payments or principal repayments. Also these bonds are more sensitive to economic downturns. If you do want to invest in high yield bonds, then diversify your selection of bonds. This will help soften the blow if one issuer defaults on payments.
You can also have a “laddered” portfolio. This is when you have bonds with different maturity dates – short term, intermediate term and long term. With this kind of portfolio, you get back your principal amounts at different times. So when one bond has reached its maturity, you can reinvest the money, if you choose to, especially if interest rates are rising. If interest rates are falling, you still earn interest from your long term investments.
The “barbell” strategy is similar to the “laddered” strategy, except that you skip the intermediate term bonds. This works well if your long term bonds have good coupon rates. Being able to redeem principal in the short term again means that you can reinvest the money, if the market situation is good.
Asset allocation is another way to go. It is known that stocks and bonds often go in different directions. When stocks are up, bonds are down and vice versa. This means that in cases when your stocks are down, your bond investments could compensate any losses you incur. Combining the two assets could actually stabilize your portfolio.