Adding bonds to your portfolio

Bonds can create a balancing force within an investment portfolio. If you have the majority of your portfolio invested in stocks, adding bonds can diversify your assets and lower your overall risk. So, how do you go about adding bonds to your portfolio and more importantly, why should you?

Investors can buy individual bonds directly from a broker or a licensed securities dealer. But there are some critical things to bear in mind:

1. Spreads and other fees- Brokers/securities dealers charge a spread and may also charge other fees. The size of that spread will determine the price you pay when buying a bond. Additionally, some brokers deduct fees out of your interest payments and/or charge management fees. These affect the return on your bond investment, so shop around to find the broker that is giving you the best price on the bond you are looking to buy and find out what other fees you will incur.
2. Individual bonds must be purchased whole- Bonds are issued in certain minimum quantities and usually increments of $1,000 (or US$5,000 for municipal bonds) thereafter. This is critical information, because some brokers will buy bonds that trade in large minimums and sell portions to their investors. If you are one of those investors, this could affect your ability to sell the bond before maturity and the price that you get. Why? Because your piece of the bond cannot be sold directly into the market and so you are relying on the broker to buy it back from you. They may or may not be willing to do so, and they may buy it back from you way below the market price.

One of the most popular cases for buying individual bonds is the ability for investors to lock in a specific yield for a set period of time. The price of the bond may fluctuate while you hold the bond but provided the issuing entity does not default because of extreme circumstances, such as bankruptcy, you will receive 100% of your initial investment when it matures. Therefore, there is no "loss" of funds as long as you hold the bond until it matures (or is called). This strategy offers stability.

The other main reason to invest in bonds is that they offer a reliable cash flow, which makes them an attractive investment option for income investors and retirees. Interest rates on bonds are usually greater than those on savings accounts at banks, CDs, or money market funds. Fixed coupon bonds pay a specified amount of interest, usually twice per year, so you know exactly how much you are getting and when. If you create a portfolio with several bonds that pay at different times, you can create a steady, predictable income stream for yourself.

In conclusion, bonds are generally less volatile and riskier than stocks, and when held to maturity, they provide constant and consistent earnings and so can be a valuable addition to your investment portfolio. Talk to your financial advisor to find out which bonds are right for you.

Toni-Ann Neita-Elliott, CFP is the Vice President, Sales & Marketing at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm   

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