We often hear “strings and chains.” Stocks represent ownership of companies; bonds pay back debt, money that is borrowed by a company or government. Bonds have a face value (principal), interest and maturity. It generally assumes one bond for $1000 of borrowed currency. The borrower receives interest twice each year and pays back $1,000 at the end of the loan period, which may be one, three, five, 10 years or more.
The servant will receive the face of the bond when he matures. If he wants to sell the bond before the term, he will receive more or less in the face amount depending on how the interest rate at the time of the sale compares to the real rate of the bond itself. If a bond’s interest rate is 3% and the prevailing rate is 6%, no one would want to buy a 3% bond when they could buy a new one at 6%. Therefore, if sold before maturity, the bond is worth less than $M. Also, if the US currency is only 1%, a 3% bond will bring in more than $1000. When interest rates go up, the present value of the bond goes down. When interest rates go down, the value of the bond goes up. The bond can be redeemed at maturity at full face value. Current yield is the annual interest rate divided by the current price. Coupons are guaranteed for the life of the bond. The market rate changes daily as interest rates change.
Bonds, like stocks, carry many types of risks. Default is the risk of a company or a government that will not be able to get its money back after borrowing money. If a company, a recent example is GM, goes bankrupt, the employee doesn’t get all their money back. Estimates are GM will get only 10 cents on the dollar while stockholders will get none. The greater the risk of failure, the greater the interest in to borrow money. As we saw in the previous paragraph, risk is important. The risk is present if the foreign exchange is not in US dollars. Reinvestment risk comes from care and principal in investing at a lower interest rate. A possible loss of purchasing power comes if the inflation rate exceeds the interest rate. And the longer it matures, the greater the risk, the greater the interest. The longer the term of the bond, the greater the price volatility resulting from changes in the market.
There are several types of bonds: external and domestic corporate bonds; bonds issued by firms, certain companies and bonds issued by companies are likely to fail. Government bonds are municipal, state, and federal, as well as US Government Savings Bonds and I-Bonds (inflation-protected ). US government bonds are the safest bonds because there is a very small chance United will default on its debt. As a result, government bonds will have lower interest rates.
An investor buys bonds the same way stocks are bought, through a brokerage firm or commercial bank or directly from the federal government (TreasuryDirect.gov). Individual bonds usually have a commission ranging from 0.5% to 2%; There is no mandate on bonds purchased directly by the US government. Individual bonds are riskier than bond mutual funds or exchange traded funds ETFs, which consist of a collection of bonds sold. one package Mutual funds have an annual management fee and ETFs have a transaction fee and an annual management fee. ETFs have perhaps the lowest total fee followed by mutual funds. We recommend an ETF that contains a wide selection of different types of bonds. BND is the symbol for the PROMOTERS ETF, which aims to track the performance of a broad index of bonds; investing index sampling.
Currently (June 2009) interest rates are very low; just as they were going it was over. When interest rates go up, the price of individual bonds and bond mutual funds and ETFs will go down. However, interest rates are expected to remain relatively low for 12-18 months and only rise when the economy picks up. Broad bond indexes are currently yielding between 4% and 5%, and your money is in a better place right now than CDs and savings .
Should you have bonds in your investment portfolio? The answer is yes, you should have bonds in your portfolio. As a coin coach I generally recommend that each portfolio contain no more than 50% equities (stock). The rest of your portfolio should contain money not tied to the stock market, such as cash and several varieties of bonds. The portfolio may include other non-equity investments, such as real, collectibles, and trading. Your interest on bonds depends on your age, your goals, and your overall financial situation. Ask your financial advisor.
