The last few posts, I’ve written extensively on investing in Alternatives as a viable asset class; from hedge funds and liquid alternative mutual funds, to precious metals. In this weekend’s post I’ve decided to discuss bonds as an asset class.
The two main macro asset classes are equities (or stocks) and fixed income (namely bonds and cash). From those broad allocations an investor spreads out into cap weightings and style (MidCap, small cap, growth, value, etc.) and fixed income type (high yield, corporate, treasury, long duration, short duration, etc.). With the exception of the most aggressive stance (100% long equities) most financial professionals do recommend a portion of their client’s assets be invested in bonds. The closer one is to retirement, OR the more risk-averse the client is; the higher the allocation to bonds (less to stocks).
Bonds do come in all shapes and sizes: high yield or junk (credit risk more than duration risk), treasuries (zero credit risk but duration risk is apparent, depending on duration/maturity of underlying bonds), mortgages (pre-payment and credit risk, much less duration risk) and TIP’s (return based on inflation data, zero credit risk, but does have duration risks), Municipals (tax free for the most part, credit and duration risks however). For all the types and styles of bonds offered, each offer their own merits as well as their own sources and levels of risks. Two ways to mitigate this risk is diversification and laddering maturities.
Fixed income diversification can be as simple as purchasing an all-around bond mutual fund or ETF ( $AGG for example ). As complex as fixed income investing is, diversification among the asset class is fairly simple. There is a vast amount of bond funds offered in the market place, managed by very capable managers with proven track records.
Laddering is a method of mitigating interest rate risk by investing in individual bonds of possibly one of the Laddered ETF’s . Bond Ladders Do offer investors an edge as the investor can have latitude in the types of bonds they plan to invest in and they worry less about bond market volatility since the ladder matures in stages. Read about ladders Here.
The purpose of this post was to provide a primer for fixed income investing. I do feel that bonds have their place in EVERY investor’s portfolio. They offer predictable income (based on the bonds’ Coupon rates ) and they serve as a ballast to any portfolio. I always have a portion of my personal portfolios invested in bonds as they service as a source of diversification and stability during volatile times.