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Janice France-Pettit: Bonds can be an exciting part of a portfolio

Union Bank

Posted: December 18, 2009 4:42 p.m.
Updated: December 19, 2009 4:55 a.m.
 
Traditionally thought of as the “safer” investment, especially for older investors, bonds have recently come into the limelight as a good way to diversify and protect against stock market fluctuations.

However, bonds are not without risks. As 2009 comes to a close, now may be a good time to review the different types of bonds available and the levels of risk involved.

Bond Basics: Governments and companies issue bonds to fund specific projects or daily operations. When you buy a bond, you are loaning your money for a certain period of time to the issuer.

In return, bond holders receive an interest payment plus the principal at maturity. The life span of a bond and the interest payment are fixed.

However, because bonds are bought and sold just like shares in a company, there are variables a wise investor may want to consider. A bond’s market value is related to current interest rates. While the interest payment is fixed, the interest rate that is paid out is not.

This means the value of the bond fluctuates according to interest rates. When interest rates fall, bond prices rise and vice versa.

Types of bonds
There are several common types of bonds, each with a varying level of risk.

Treasury bonds, bills and notes issued by the U.S. Treasury are backed by the U.S. government and are generally thought to have the lowest risk of default.  

Government-agency bonds are issued by a U.S. government agency such as the Government National Mortgage Association (GNMA or Ginnie Mae) or the Federal National Mortgage Association, which are more commonly referred to as FNMA or Fannie Mae. These are considered to have high credit quality.

Corporate bonds issued by financially solid, well established companies have relatively low default risk, while high-yield corporate bonds may offer the potential for higher returns in exchange for higher default risk.

There are some bonds that can be tax-exempt like municipal bonds, which are bonds issued by local government entities or agencies such as cities or school districts—often offered to make improvements or fund construction projects.

These may yield less than taxable bonds, but may result in higher returns depending on your income bracket.

Risks
With bonds, you may want to consider the risk that the issuer will default on its loans.

For example, during 2009 the bond market was unsteady due to these types of credit risk fears.  

Investors may also consider bond ratings to guide them when selecting bonds and determining risk. Bonds with the highest credit rating (typically AAA) are most likely to make payments and may have little risk of default.

Lower-rated bonds such as BB to B have higher default risks, while CCC to D bonds are the highest risk.

Interest rate changes, as discussed above, are also a risk to consider. Bond prices and interest rates move in the opposite direction. So if interest rates rise, bond prices fall, making bonds subject to inflation.

Inflation can impact the value of a bond’s fixed interest payments. Stocks are generally thought to outpace inflation.  

Use of bonds
Bonds are often thought of as retirement vehicles due to their payment component. The income they generate may help supplement a retirement income.

Bonds may also be a good option for investors wishing to diversify their portfolios and reduce exposure to stocks. Consult your financial adviser for the right mix of stocks and bonds based on your financial goals.

Investment strategies
Many financial advisers may recommend a ladder portfolio of short and intermediate-term bonds to help steady income and spread risk. Spreading your money among bonds from a broad range of issuers may be a good strategy. You may want to consider bonds from treasuries and other government bonds to high-quality corporate offerings. Diversifying in this manner may be a good option.

Bonds may be an exciting investment option to consider. Consult your financial adviser for help selecting bonds to add to your portfolio.

The foregoing article is intended to provide general information about creating a trust and is not considered legal, financial or tax advice from Union Bank. Trusts, wills, foundations and wealth planning strategies have legal, tax accounting and other implications. Please consult a legal or tax adviser. Janice France-Pettit is a senior vice president and regional manager for Union Bank, overseeing the Simi Valley, San Fernando Valley and Antelope Valley regions. Her column reflects her own opinion and not necessarily that of The Signal.

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