If you're looking for safety in your volatile stock portfolio, bonds can be a calming force. Here are some tips on how to buy them.
Securities come in all types: the dogs of the Dow, fast-moving Greyhounds, unpredictable Pit Bulls, and sluggish Basset Hounds. Amid the various moving parts of your diversified portfolio, don't forget that there's a place for bonds-the predictable, dependable St. Bernard of the investment world.
Bonds are debt instruments. The bond issuer, usually a government entity or a corporation, borrows a sum of money from you, the bond investor. In return, you receive periodic interest payments until the bond matures. At maturity, your invested principal is then returned. The main risk you take on as a bond investor is that the issuer will become insolvent and unable to make the interest payments or return your money.
Sizing up the options
You can buy corporate and government bonds and bond mutual funds through full-service, discount, or online brokerages. You can also buy Treasury bonds directly from the federal government via the TreasuryDirect (savingsbonds.org) online system. If you go through a brokerage house, clarify how you'll be charged for bond trades. Some brokers add their commission to the bond price, so that you can't readily tell what you're paying in fees. Treasury bond purchases through TreasuryDirect are commission-free.
Choosing the right bond investment can be as simple or as complex as you decide to make it. Conventional wisdom says that if you don't have the time for research, and don't have access to a financial advisor, go with Treasury bonds. The federal government isn't likely to go bankrupt, so there's very little risk involved.
If you prefer something more exciting than a Treasury bond, evaluate your options by looking at a company's bond ratings. The three widely referenced ratings companies are Standard & Poor's, Moody's Investors Service, and Fitch. These companies conduct extensive and ongoing research to gauge bond issuers on their financial stability. Each company has its own rating system, but higher ratings mean higher quality bonds.
Next, consider the structure of the bond and how it addresses your financial goals. You'll need to know when the bond matures and how often interest payments are made. Take note of a bond's call options. These allow the issuer to pay off the bond before maturity. This is done if market interest rates drop significantly, and the issuer could save money by paying off the old bond and issuing a new one at a lower rate. You'll get your money back, but you won't be able to reinvest it at the same rate you were earning previously.
You don't really want to look upon your investment portfolio as a pack of dogs. But you do want to make sure that you aren't over-exposed to short-term stock market volatility that can bite you in the rear. High quality bonds can provide that necessary predictability in otherwise uncertain times.