- We often get questions from investors about owning bonds.
Collin, can you give us some insights about bond investing?
- We see three key reasons why people should own bonds regardless of the interest rate environment and regardless of the economic environment.
Those reasons are income, relative price stability and capital preservation, and the diversification benefits they provide.
The first benefit is income.
Bonds are contractually obligated to make interest payments, so barring default, you generally have a good idea of how much income you'll
be receiving and when.
The second benefit is relative price stability and capital preservation.
Bonds have set maturity dates and set par values, so you can generally have a good idea--
once again, barring default-- of how much you're going to receive at its maturity date.
Now, bond prices can fluctuate in the secondary market, but for high-quality bonds with short- to intermediate-term maturities, the price volatility is significantly less than those seen in the stock markets.
And the third benefit is diversification. For a well-balanced portfolio, it's best to have investments that aren't all moving in the same direction.
Over time, the prices and returns of high-quality bonds, like U.S. Treasuries, aren't very correlated with stocks.
So during periods of stock market volatility or stock market declines, holding high-quality bonds can help serve as a
ballast for your portfolio and could limit the overall decline if we did experience some stock market volatility or price declines.
- Those are three great reasons to own bonds. Can you tell us about the risks?
- Bonds generally have two key risks, interest rate risk and credit risk.
Interest rate risk is the risk that a bond's price will fall if its yield rises because bond prices and yields generally move in opposite directions.
But not all bond prices will fall by the same amount. A major determinant in price sensitivity to a change in yield is time to maturity.
Short-term bonds tend to be less sensitive to changing interest rates than long-term bonds.
Now, the second key risk is credit risk, or the risk that an issuer can't make timely interest or principal payments or generally leads to a default.
Now, some bonds, like U.S. Treasuries, have very low credit risk, but other bonds, like high-yield corporate bonds or emerging market bonds, have heightened credit risk and therefore amounts to more price volatility.
Now these types of bonds generally have lower credit ratings and have the potential to suffer price declines.
- Thanks for talking to us about the risks as well as the benefits in owning bonds.
You can find more information about investing in individual bonds, ETFs, and mutual funds, as well as separately managed accounts, on Schwab.com.