Bonds may generate income, reduce portfolio volatility

Bonds are a staple in many portfolios for several reasons:

• They can provide regular income;

• They have the potential to lower a portfolio’s overall volatility; and

• They can provide a means of diversification in a general investment mix.

Any investor who pays for living expenses or other regular obligations with money from their investment portfolio knows how important it is to generate income from that portfolio. Bonds are probably most commonly known for their potential to generate income because of their regular interest payments.

These payments vary by bond issue, but they can be made on a semiannual, quarterly or even monthly basis, and they can add to the income earned from a portfolio. Consider, for example, an investor who buys a bond and then watches it decrease in value. Fortunately, the income stream from this bond would still add to the investor’s total return, helping to ease the pain of the loss in market value.

Riding market ups and downs

Many investors worry about how the ups and downs of the market will affect the value of their portfolios. While stocks have historically provided greater returns, bonds have been less volatile, thereby providing more stability in the overall investment mix. It is important, however, to remember that past results may not be indicative of the future.

In simple terms, volatility can be described as the degree to which the price of a security – or an entire portfolio, for that matter – fluctuates during a given period of time.

It is important to pay particular attention to this concept when you invest to meet any time-sensitive investment objectives. It’s usually advantageous to begin to reduce the fluctuations in your portfolio as you approach the time you think you will need to use the money from it. As a significant part of a well-diversified portfolio, bonds can help you preserve principal and meet specific investment objectives.

Revisiting diversificiation

To expand on the earlier definition of diversification, it means investing in assets in different categories with the intent of reducing overall risk. Diversification neither ensures a profit nor guarantees against a loss. Naturally, there would be inherent risks associated with the individual securities in a portfolio. But by spreading overall risk over a number of investments, it allows the opportunity to balance things out and to avoid being subjected to the full risk of any one piece of the puzzle.

While bonds aren’t entirely without risk, they can still provide regular income, help preserve principal, and work to reduce the overall volatility of a diversified portfolio. Keep in mind that bonds can experience price changes for a variety of reasons.

All bonds are subject to interest-rate or market risk, so it’s important to understand how that could affect your investment if you decide to sell bonds before their maturity dates. Individual risk tolerance and suitability should always be considered before selecting any investments. If you’re looking to build a well-diversified investment portfolio, however, remember that bonds cam be among the basic starting points.

Timothy M. Reese is senior vice president-investments with A.G. Edwards & Sons Inc. Member SIPC. He can be reached at timothy.reese@agedwards.com.[[In-content Ad]]