13 Dec 2016
The Best Way to Add Bonds to Your Portfolio
The case for bonds is likely familiar to most investors. If a portfolio were a ship, bonds would be the ballast—providing a measure of stability. They’re a counterbalance to riskier investments like stocks, and can help you manage volatility over time. Perhaps, the best way to add bonds to your portfolio. In general, bonds and bond funds respectively provide income and diversification from stocks. But it’s worth weighing the differences before you choose.
Most investors are drawn to individual bonds because of the reliable source of income they provide. Bonds are issued by governments, businesses and other organizations, and usually make interest payments for a set number of years. Bonds’ regular payments and predetermined lifespans make them appealing for people who want to plan for predictable cash flows.
Investors in individual bonds should also consider these features:
Diversification. Research by the Schwab Center for Financial Research found that holding investment-grade bonds from 10 or more issuers may greatly improve portfolio diversification. That can mean investing $100,000 or more to build a diversified corporate or municipal bond portfolio (assuming $10,000 per bond). Your portfolio shouldn’t have too much exposure to a particular issuer, sector or type of bond. Also, make sure you understand each issuer and each bond to see they match your goals and risk tolerance.
Liquidity. If you should need to liquidate a bond before it matures, it can sometimes be challenging to find a buyer. Some types of bonds can be thinly traded at times, and there’s no guarantee that someone will want to buy a bond at the price you are asking for it.
Bond mutual funds hold multiple bonds and can be managed either actively by an investment manager or passively to replicate an index. Bond funds can also focus on broad or narrow parts of the market. But in general, holding multiple bonds adds a level of diversification, because multiple bonds involve multiple issuers and maturities.
Bond fund managers may be able to buy bonds at better prices than an individual investor because they buy larger blocks. And bond fund management companies may also have dedicated research departments that handle security selection and monitoring, which can be particularly helpful if an investor wants access to an unfamiliar or complex part of the market.
Another potential advantage bond funds have over individual bonds is that they may make it easier to set up automatic investment plans and reinvest interest payments. With a no-load, no-transaction-fee bond fund, you can regularly contribute smaller amounts to build your investment over time, whereas building up an investment in higher-cost individual bonds might be more difficult.
What to do now?
Whether you’re looking for steady income, potentially lower volatility or greater portfolio diversification, bonds or bond funds can help. To determine which is right for you, think first about your attitude toward risk, how actively you want to participate in managing your portfolio and how much you’d like to invest.
And remember, this doesn’t have to be an either/or decision. The relative predictability of individual bonds can make sense in lower-risk areas of the market, such as Treasuries, municipal bonds and investment-grade corporate bonds. The easier management and diversification possible with bond funds can be appealing in areas where risks are higher, like high-yield/subinvestment-grade corporate bonds and international bonds. You may find that combining the two can help you meet your goals.
This material is issued by Charles Schwab, Hong Kong, Ltd. The information provided here is for general informational purposes only and has not been reviewed by the Securities and Futures Commission in Hong Kong.