Bonds are debt instruments issued by companies or the government that pays a certain amount of interest, and the full principal amount at the maturity date. The interest rate for bonds depends on a variety of factors, such as the current market interest rates, the maturity date, and the creditworthiness of the issuer. In general, investing in bonds alone is not enough to help you meet all of your financial goals. However, fixed income securities can help you reduce risk and preserve your principal. This makes them especially handy when the stock market goes south.
Bond Prices and Interest Rates
Many investors think that the price of a bond stays constant, but this is not the case at all. Bond prices fluctuate more than most people realize.
- What makes the bond prices fluctuate? Interest rates. In general, when interest rates go up, bond prices fall; and when interest rates fall, bond prices rise.
- When is the best time to buy bonds? When interest rates rise, bond prices tend to fall, and the yield increases to match prevailing interest rates. This is usually an excellent time to buy, especially if you plan to hold them until they mature.
However, trying to time the bond market is about as futile as trying to time the stock market. Instead, you should determine how much risk you’re willing to tolerate and build an investment portfolio that matches your risk tolerance level. Hold more bonds if you are risk-averse, or if you are closer to retirement and can no longer afford the risk.
Rule of Thumb for Investing in Bonds
There’s a popular rule of thumb that states an investor should have a percentage of his portfolio that is equal to his age invested in bonds. For example, if the investor is 20 years old, then 20% of the portfolio should be in bonds. This is a bunch of baloney! The percentage of bonds in a portfolio has nothing to do with the age of the investor. As mentioned above, a portfolio’s bond allocation should be based on an individual’s risk tolerance level — not just the age alone.
Andy is a 30-something New Yorker who turned his financial life around. He took charge of his finances, got out of debt, and is now working his way toward financial success. He is the owner and publisher of WorkSaveLive.com.