I spend a lot of column space talking about equities (stocks). Whether U.S. or international, large cap or small cap, or value or growth, equities are a way of buying a small ownership in the future profits of companies. For investors, these shares of various companies are a key part of their portfolio.
A second very common part of most investment portfolios is bonds. So, what are bonds, and why are they generally considered to be such an important part of investment portfolios? Simply put, a bond is a loan that you make to a business or government, and in return you get the promise of two things: periodic interest payments (perhaps monthly or quarterly, as examples), and your money back at the end of the deal term.
As an example, let’s say that today I can buy a hypothetical $10,000 bond from Apple with a 4% coupon, paid semi-annually for 5 years. Here’s how this would work. First, I would send Apple $10,000 to purchase the bond. Then, every 6 months, Apple would send me an interest payment of $200 (half of 4% of $10,000). At the end of 5 years, I would receive a payment of $10,000 from Apple, the exact same amount that I paid for the bond originally.
When the dust settles at the end of my 5-year bond investment example, I would have received a total of $12,000 (ten $200 semi-annual payments plus the $10,000 bond payout) in exchange for my initial investment of $10,000. That kind of investment income won’t make me a millionaire, but it’s a fair return for the level of risk in the investment (I’ll talk more specifically about those risks in a future column).
We all know that it is not uncommon to lose money on an equity investment, especially in the short run. It is also possible to lose money on a bond investment! If the company or government entity you’ve lent your money to sees a change in their financial situation, that can affect the short-term value of the bond (in more extreme cases, the long-term value). But even in that case, as long as the entity isn’t in bankruptcy or financial restructuring, you are likely to get your full payment at the end of the bond term. Interest rates changes can similarly affect the short-term value of your bond.
Bonds are generally thought of as having a lower level of risk and lower expected returns when compared to stocks. That makes perfect sense—nobody would sign up for a lower rate of return if you still had to take the same amount of risk! It also makes bonds a nice compliment to stocks, and enables investors to personalize the level of risk that they take in their portfolio.
My next column will take a deeper dive into bonds and how to position them in your investment portfolio.
How ever you choose to use bonds in your portfolio, invest smartly and invest well!
Larry Sidney is a Zephyr Cove-based Investment Advisor Representative. Information is found at https://palisadeinvestments.com/ or by calling 775-299-4600 x702. This is not a solicitation to buy or sell securities. Clients may hold positions mentioned in this article. Past Performance does not guarantee future results. Consult your financial advisor before purchasing any security.