When you include bonds in your portfolio, you are adding diversity and offsetting potential risks to your investment. Consider these strategies as you prepare to begin bond trading.
Reduce overall investment risk
Stocks may go up over time, sometimes with spectacular results. But they can also stagnate, lose value, and, in rare cases, lose their worth altogether. Bonds can be a more secure way to maintain the value of your investment while still receiving acceptable returns, because the issuer has promised to repay 100% of the bond's face value.
There is still risk involved in your bond investments. Depending on the issuer, some bonds may have more risks than some stocks. It's possible the issuer will default on making interest payments. They may not be able to repay the face value of the bond, which means your investment is gone. In most cases, bonds tend to be a lower-risk (and therefore lower-return) investment than stocks.
Practice asset allocation and the rule of 100
One way to reduce risk with your investment portfolio is asset allocation. Try the Rule of 100 strategy — subtract your age from 100 to find the percentage you should consider investing in stocks. For a 30-year-old, that means investing 70% of your assets in stocks (100-30) and the remainder, 30%, in bonds. As you grow older, the balance starts to tip the other way. At 55, the Rule of 100 encourages you to invest 45% of your assets in stocks and 55% in bonds. At 70, you might shift to 30% stocks and 70% bonds.
Invest with a shorter time horizon
For preserving capital and getting a return on your investments in a relatively short period of time (five years or less), bonds might be the right choice. You'll probably want to shift more investments into capital-preserving assets like bonds for financial goals like funding college.
Invest in bonds before and during retirement
As you near retirement, investing in bonds might reduce your exposure to the potential downside of the stock market. If all of your money is invested in stocks and the market is weak, you might not want to sell your shares, preferring instead to wait for a rebound. If you're retired, you may be forced to sell to meet your expenses.
With bonds, on the other hand, the interest you receive can provide a source of income that you use to pay your bills during retirement while preserving a known percentage of your investment capital. As a result, some investors choose to weight their portfolios more heavily toward bonds as retirement approaches.