Sunday, September 23, 2007

Uses Of Bonds

As you have already learned, bond investments are interest earning and its value can appreciate or depreciate in relation to interest rate changes.

Bond is generally a safe investment. However, except for bonds from the government, bonds do carry the potential risk of default, no matter how remote that risk might be.

Bonds would appeal to those who want to receive interest income or to preserve and to accumulate capital. If you want regular returns of a certain amount of money, a bond will fit the bill very well.

Bond is a better alternative to savings and fixed deposits. If you wish to invest your money safely for a longer period of time, bonds serve this purpose better than fixed deposits. You can beat inflation and enjoy higher returns than fixed deposit rates.

Due to the conservative nature of bonds, it is one of the investment tools that could be added in any phase of your retirement portfolio. Your holdings in bonds would vary depending on your risk tolerance and investment time horizon.

If you are young and have many years away from retirement, you are most likely to build your nest egg by taking a fairly aggressive stance. However, it would be unwise to put everything into equity as it is a very volatile instrument and are generally the most risky. You would probably have a diversified investment portfolio that consists of bonds, equities and cash in varying allocation. Diversification offers some protection for your portfolio as the rising value of certain assets could help to offset the assets that are facing a negative impact. By adding bonds in an equity portfolio, it would enhance stability and reduce risk exposure as your capital in bonds would likely to be protected from equity market fluctuations.

If you are a few years away from retirement or have retired, you need to protect yourself from possible steep equity declines. You can shift from an aggressive stance to a moderately aggressive one by adding more bonds. As you receive a fixed amount of income that is paid regularly over the lifetime of the bond, the predictable cash flow from bond investment adds a necessary element of stability to the retirement portfolio.

As lower risk often leads to lower returns, the emphasis of investing in bonds generally does not lay in capital appreciation, but in, income generation and capital preservation. If you invest in bonds of good credit ratings, you will most likely get back your principal upon maturity. As it is possible to incur a capital loss if you were to sell before the bond matures, you will need to consider when you want the principal to be repaid and the kind of returns you seek, and take into account your risk tolerance.

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