Why Everyone Should Own Bonds

The challenge of bond investing is aggravated by the fact that unlike stocks, there’s really no easy way to check daily prices of individual bonds. Still, pricing has become clearer. Almost every discount and full service broker has ongoing bond quotes available to you. And there are now a ton of corporate bond trackers and pricing services available to you online now. Even the Municipal Securities Rulemaking Board, or MSRB, has beefed up its municipal pricing for free. And government-bond data is available on the Treasury Department’s Web site at treas.gov. So… those are some great resources to keep you updated on the daily prices of individual bonds.

Most major discount brokerage firms offer government, corporate and other bonds. Those firms that cater to individual investor’s, like Fidelity and Schwab, also handle bond investments. So, depending on the size of your portfolio and your tax bracket, you may want to use a tax-yield equivalent calculator to see if municipal bonds are more advantageous for your situation. And under the new tax rates, you might want to consider tax free municipal bonds versus taxable corporate bonds; Make sure you’re doing your homework when you’re investing in bonds.

With bond funds, investment research company Morningstar suggests a formula. First, determine how much a bond fund stands to gain or lose based on what’s called “duration.” Duration is a measure of how sensitive a bond fund is to movements in interest rates. I’ve talked about that many times before here on the radio. Duration is expressed as a number. For example, a duration of 5 means that for every 1% shift in interest rates, the fund’s value changes by 5%. For example, if interest rates go up by 1% the fund would lose 5% in market value. If interest rates fall 1%, the fund would gain 5%. You get the idea. Understand this term as it’s overlooked by both investors and many financial professionals.

Bonds are commonly considered less volatile investments and lower-risk than a stock portfolio. Yet bonds leave a lot of people wondering: How much of my investment plan should I allocate to bonds? Are fixed income investments only for those people who are nearing retirement? Well, let’s dispel some myths this week. Given bonds relatively high trading costs, and with pension funds dominating the bond market most of the time, most investors opt to invest in mutual funds… or even invest in exchange-traded funds over direct bond purchases. I often tell people that corporate bonds, high-yielding bonds, and higher risk junk bonds, and yes – even municipal bonds… all are best purchased through mutual funds unless you have the research backing or enough money to properly diversify.

Expenses cut your bond returns even more than they cut into your stock returns. Bonds are usually low-risk, low-return. Our recent climate is a prime example. Single percentage-point returns: 2, 3 even 4 percent – are about the best available. Ideally, you should look at bond funds with expense ratios no higher than about a half of a percent. If costs are higher, make sure the fund’s performance more than makes up for it. It’s very difficult to differentiate yourself as a bond manager. It’s not like running a bunch of high flying stocks, if you’re a portfolio manager. So again, it’s critical when evaluating bonds and bond funds that you focus on the transaction fees and expenses involved with owning them.