Last week, we began discussing the importance of properly diversifying your bond portfolio in order to effectively balance those two key elements of investing: risk and reward. When it comes to fixed-income investing, there are six important considerations, and we covered the following three:
- Pay attention to quality!
- Think about maturities!
- Don’t ignore your tax bracket!
As promised, here are the final three principles that fixed-income investors should think about.
Don’t forget investment considerations! We’re talking ‘risk’ here. All investments…including bonds…have certain inherent risks that investors should never ignore. Bond investors must be mindful of credit risk, but they also need to pay close attention to interest rate risk, reinvestment risk, call risk, and market risk! And…if you sell in the secondary market, you may receive more or less than your cost or the bond’s face value.
Pursue broad diversification! The U. S. fixed-income market offers a wide array of excellent choices including but not limited to corporate, municipal, Treasury, mortgage-backed, and inflation-protected bonds. But wait…there’s more!! Foreign governments and corporations also issue bonds, and adding them to you portfolio might be a good way to enhance diversification. Please note, however, that investing in foreign markets entails additional risks: currency, political, and market to name a few. Most investment managers believe that international investing should comprise a limited portion of one’s portfolio.
Don’t overlook gain/loss tax considerations! Gain/loss consequences are not limited to equity investing. If you sell a bond prior to maturity, you may create a capital gain or loss depending on factors such as interest rates, market conditions, and credit quality.
When it comes to investing in bonds, getting it right can be complicated…and…not all bonds are created equal!