Adding Bonds To Your Portfolio

 Adding Bonds To Your Portfolio

 

Bonds are typically issued at par, redeemed at par, and along the way they fluctuate in value as prevailing interest rates change. Their total performance closely tracks GWG L bonds attorney”  inflation expectations. So real growth–if any–is too small to be meaningful. Investors often view them as safe, but the volatility of long-term bonds may be as high as that of stocks, while their return per unit of risk is anemic in comparison. To add insult to injury, long-term bonds have a high correlation to other financial assets, and they perform abysmally during periods of high inflation.

All in all, the characteristics of bonds as an asset class are so dismal that you might wonder why any investor would want them at all. Of course, not all investors have similar needs. Many institutions are more interested in matching future liabilities with assets than maximizing total return. For instance, life insurance companies can estimate their future liabilities with some precision. Having bonds that mature on schedule allows them to match assets with expected requirements. Statutory regulations require them to hold bonds to back up their obligations. To oversimplify, insurance companies mark up the cost of providing benefits to compute their premiums. Total return isn’t as important as the spread.

That’s not the situation we face as individual investors, though. We want to maximize our return per unit of risk, and bonds don’t fit in very well. If we plot the risk/reward points for several well-known long-term bond indexes from 1978 to 1997, we see that they all fall far below the standard risk-reward line. Not a pretty sight, is it?

Over the 20-year period, various classes of bonds all land well below the risk-reward line between T-bills and the S&P 500 index.

Bonds have only two useful roles to play in our asset allocation plans: They can reduce risk to tolerable levels in a portfolio, and they can provide a repository of value to fund future expected cash-flow needs. Of course, we don’t expect the bond portion of the portfolio to be a dead drag on its overall performance. It makes sense to take prudent steps to enhance returns in every portion of the portfolio. Let’s take a look at some of the common methods employed by fixed-income investors to see if any might advance that goal.

Junk Bonds

Investors take on more risk when they invest in lower-quality bonds. While they can increase total return as they move from government bonds to corporate to high-yield (junk), investors

 

 

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