6 Tips on Investing in Bonds
The inherent stability and predictable rates of return is one of the most appealing aspects of bond investing.
However, investing in bonds, like any financial instrument, is not as simple as it appears to be at first glance.
When investing in bonds, you need to make sure that they're playing the right role within your portfolio, that you're properly diversified, and that you're getting a rate of return high enough to make the investment worth it.
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Build a Ladder Strategy When Investing in Bonds
This is a strategy favored by many people who invest in financial products that have a set term. The idea is to invest in bonds in a staggered fashion. This way, when the bonds start paying you interest, you can be assured of a steady flow of income.
A ladder strategy creates a couple of favorable situations when investing in bonds.
1. First, it helps ensure a steady cash flow from having a number of active, interest bearing investments.
2. Second, it helps ensure that you have a consistent infusion of your principle being returned to you when the bonds are due, which you can either invest back in bonds, absorb as cash or invest in other products as the market dictates.
Selling or Trading Bonds Strategy
You don't have to hold bonds until maturity, although that is a safe and common practice for investing in bonds.
However, it is possible to sell or trade bonds before they reach maturity. This is a very difficult strategy to achieve good results from unless you're highly educated in financial matters and can predict the bond market.
Typically speaking, when investing in bonds, don't try to make a quick buck by selling or trading them if they happen to increase in value. Instead, look at them as a cash flow instrument and also as long-term investments.
Investing in Tax-Free Bonds
If you are in a higher tax bracket, then your investing strategy should incorporate reducing your tax burden as much as possible.
This is an important part of an overall strategy for growing wealth. It applies to investing in bonds as well.
Municipal bonds are tax free. These bonds are offered by local or state governmental organizations. These types of bonds are beneficial because the interest paid on them tends to be tax free.
The exact tax situation should always be double-checked before you make a purchase because certain bonds might only be exempt from federal tax while others might be exempt from both federal and state tax.
While the interest on these types of bonds might be lower than some other options in the bond market, the amount that you save on taxes might actually mean a higher total rate of return.
Minimize Investing Fees
Bonds typically come with higher purchasing fees than stocks or other financial instruments.
If you're investing heavily in bonds, you need to shop around to try and find the best deals; not just on the bonds themselves but also on the fees and commission that you'll be paying to the agency you're buying them through.
You'll have to shop around between brokerages to find the best rates on investing in bonds. Any time you have the option of buying a bond directly, you're going to cut out another party, who needs to profit on the transaction, and save yourself some money.
For federal government bonds, you can do this by purchasing directly through the government's website, Treasury Direct.
For other types of bonds, you can sometimes buy them directly from the bank that is underwriting the bond instead of having to pay commission to a broker.
Replicate an Index Fund
If you would rather be investing in bonds directly rather than owning shares in an index fund or similar instrument, that doesn't mean that you can't diversify the same way that the experts do.
Look at the bonds that are held by the most successfully performing bond funds when you start to assemble your own portfolio.
Figure out which bonds they hold and at what weight or percentage they are held at. If you mimic this pattern across your own portfolio, you'll be mimicking their diversification but protecting yourself with the stability of owning the bonds yourself.
However, because of the large number and types of bonds often held in these types of portfolios, this tends to be a high-net-worth strategy.
Weight in Overall Portfolio
The amount of your entire wealth that you should be investing in bonds is essentially determined by how much risk you like to take with your investments.
If you're an extremely aggressive, risk-taking investor, then the percentage might be as low as 10%. If you're a very conservative investor, it might be more like 70% or higher.
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