Learn how investment bonds can help round out your portfolio
Dec 26, 1998. I mentioned in an earlier article that I would discuss bonds because they are a
bit confusing to the average investor. And that’s why some people stay away from them. For a portfolio to be diversified
you should have at least 20% invested in bonds.
Bonds are debt instruments. In essence you are lending your money to the issuer for a stated
time period in return for a stated interest rate. One of the common misconceptions about bonds is that they must
be held until maturity. In fact, they may be sold before maturity, and frequently are.
The safest bonds are U.S. Government Bonds. They are backed by the full faith and credit of the
government. Short term debt instruments, one year or less, are called Treasury bills. If the term of the original
bond is 1 to 10 years, it is called a Treasury note. Debt issued for longer than 10 years is called a Treasury
Corporations borrow money from investors, too. They issue notes and bonds backed by the credit
worthiness of the issuing company, which can be ascertained by checking the company’s credit ratings. Most corporate
bonds are rated by several privately owned agencies or companies, the largest of which are Standard & Poor’s and Moody’s for ratings of the company. The higher the credit
rating, the lower the interest rate yield.
Municipal and state projects are frequently debt financed by municipal bonds. In order to encourage
local and state governments to finance their own growth and development, Congress allows municipal bond interest
to be received tax free for federal income tax purposes. You can reside in the state where the bonds are issued,
and possibly even free of city taxes as is the case for New York City obligations held by New York residents.
Zero-coupon bonds are issued by the government and governmental agencies, and often carry abbreviations
like TIGRS, STRIPS, etc. Taxes are paid annually even though interest is not received until the bond matures or
is sold. I like to ” ladder ” my bonds up to a 10 year maturity. Buy five issues, same amount of dollars
up to 10 years. Your better off purchasing single bonds than going into a bond fund because the risk factor is
greater with a bond fund.