Bonds can be used for a variety of reasons. While people tend to view bonds as boring investments their grandfathers make, they can be a very useful investment vehicle. They can be used for saving money, generating income, managing risk, or tax planning. They’re much more versatile than many investors give them credit for.
Take a look at what bonds can do for you:
1. Principal preservation. This may be the most common use of bonds. This purpose most frequently makes use of short-term, very low risk bonds, such as Treasury Bills. Low-risk bonds are a very effective way of transporting your money through time; while you won’t make a lot of money, you’ll still get some return.
* Many companies invest in bonds as a means of storing their money until some specific date in the future when they can better use it.
2. Interest-rate risk management. While this is a more complex use of bonds, bonds can be used to hedge against expected changes in interest rates. A portfolio of well-selected bonds can help you make money whether interest rates are falling or rising.
3. Saving. There is a reason federal Savings Bonds are called savings bonds. They are one of the lowest-risk ways to save money for the long-term. The federal government guarantees them and there is a wide range of options available. These options include bonds that pay interest, discount bonds, and more.
* These make great gifts, even if the typical child getting them isn’t overjoyed. Someday they’ll thank you.
4. Diversification. Bonds are an effective diversification strategy; they tend to move in the other direction from other investments. So when your stocks go down, bonds tend to do favorably. Bonds have a place in every portfolio, regardless of the goals of the investor.
* Higher risk bonds can also give high rates of return. Of course, you need to feel comfortable with the risk – that the potential reward is worth your risk of loss. Junk bonds are not for the weak of heart.
5. Plan for future expenses. You can also use bonds to match future known expenses, like college tuition. For example, if you know you’re going to need $25,000 ten years from now, you can buy a bond (or bonds) that will provide $25,000 in ten years.
6. Income. Unlike most stocks, bonds can provide a reliable and predictable stream of income over a long period of time. As you get closer to retirement age, it makes sense for you to consider moving a greater share of your portfolio into bonds.
* Companies like insurance companies and banks rely on bonds for a large part of their income. In fact, insurance companies tend to pay out as much on claims as they earn in premiums. Their real income is typically from their investments, a large portion of which are bonds.
It’s important to remember that bonds are not without risk, but the risk can be very minimal with the right homework. Understand a bond’s risk rating before investing your money.
Bonds have a wide-variety of applications beyond those that you may be aware of. Keep these useful functions in mind the next time you consider investing in bonds. Bonds can provide a reliable means of saving, preserving capital, generating income, and more. Maybe your grandfather’s investment isn’t as boring as you originally thought.