For advanced traders, corporate bonds comprise a key component of a diversified investment portfolio. But are they a good match for your financial objectives? Investing in corporate bonds might make sense for you, if:
- Bonds are a part of your asset allocation plan and you're investing a certain percentage of your portfolio in them.
- You prefer a higher rate of interest than a tax break, since corporate bonds are fully taxable.
- You're willing to take on more risk for a higher return. Corporate bonds are riskier than municipals (munis) or treasuries.
- If you already know a winning stock and could use that knowledge to allocate a portion of your fixed-income assets towards the same company's bonds.
- You want a liquid market for your bond purchases and sales. Corporate bonds issued by large, publicly traded companies are usually more liquid than munis.
Broader Market Outlook
Although it is possible to make sound investments in virtually any market environment, it's usually a good idea to evaluate the Fed's current and anticipated policy on interest rates before and while holding bond investments. If your bond's coupon rate is higher than the current interest rate target set by the Fed, your bond is going to look pretty sweet to investors, driving its price up.
If the Fed should bump up interest rates to a rate higher than your bond's coupon, your bond won't look so hot compared to new bonds issued with the higher coupon rate. Your bond's price would correspondingly drop in the secondary market.
Other concerns are market jitters or inflation. When there's great uncertainty in the stock market, there's a flight to quality among investors. Top-rated corporates may be in demand at these times. If inflation is on the rise, the concern is that it will outpace the rate of interest received from the bond investment. To combat high inflation, bond investors may be forced to turn to investments with higher risk to provide the opportunity for higher returns.