Bonds Fit in Every Portfolio
Adding some bonds or bond mutual funds to your investment portfolio is a good idea, especially if you have a lower tolerance for risk. For investors of every kind, bonds offer a wide variety of benefits.
Bonds can help stabilize a portfolio by offsetting the investor's exposure to the volatility of the stock market. Bonds inherently have a different risk and return character than stocks, so they will necessarily behave differently when the markets move. Also, bonds generally provide a scheduled stream of interest payments (except zero-coupon bonds, which pay their interest at maturity). This attractive feature helps investors meet expected current income needs or specific future expenditures such as college tuition or retirement income. Callable bonds and pass-through securities have less predictability, but investors are compensated for the uncertainty in the form of higher yields.
You'll find dozens of bond investment calculators on the Internet, mainly offered by online brokers (and even some mutual fund companies). These calculators are easy to use — just plug in the variables — and can help you decide whether a bond will benefit your tax situation. This is a far superior option to guessing whether a bond is right for you and doing the math in your head.
Unlike stocks, bonds are designed to return the original investment, or principal, to the investor at a future maturity date. This preservation of capital provides stability to a portfolio and balances the growth/risk aspect of stocks. You can still lose your principal investment if you sell your bonds before maturity at a price lower than your purchase price, or if the borrower defaults on payment. By choosing high-credit-quality bonds, you can limit your exposure to default risk.
Another noteworthy advantage: certain bonds provide unique tax benefits. For example, you won't be paying any state or local income tax on interest you've earned on your U.S. Treasury bonds. Likewise, the interest on your municipal bonds (usually) won't be subject to a federal income tax bite, and in some cases, they'll also be free of state or local income taxes, too. A good broker or tax advisor can help you determine which bonds are best for you.