Bonds are among the safest financial instruments, but investors still need a balanced portfolio strategy. Should you invest in bond funds or ETFs? Are bonds with the highest interest rates the best? These questions confuse beginners, but even seasoned investors can make mistakes.
Individuals can purchase debt securities issued by corporations or governments — for example, Canada bonds or US Treasury bonds. Bear in mind that a higher yield comes with higher risks. Here are 8 top tips from experts.
1. Look Beyond Yield
Impressive yields usually indicate lower credit qualities. All too often, investors feel tempted to buy bonds with higher interest rates when the rates for the securities in their portfolio decline. Remember that past success does not guarantee future growth. Yield is only one of the many factors you should consider.
2. Set Clear Goals
If you do not know where you are going, you will never arrive anywhere. What are you hoping to achieve by investing in bonds? Whether you need money to finance your kid’s college education or a comfortable retirement for yourself, define these goals as clearly as possible.
3. Assess Risk Profile
Different securities carry different risk profiles. Write them down and keep them in plain sight. Always examine all risks before investing. For example, bonds of emerging markets like Brazil carry higher credit risk and market risk than US treasuries.
4. Keep On Learning
Read as much as possible about bond investing. Subscribe to financial news channels and follow their fixed-income commentary. Learn to read offering statements, which contain crucial characteristics like yield and call schedule.
Before investing in a new bond fund, study the prospectus thoroughly. Pay attention to any applicable fees. Prospectuses for individual bonds are based on the underlying indenture — a legal document defining the agreement between the buyer and seller of the bond. Request a copy of the indenture or prospectus from your intermediary.
5. Assess Liquidity
To check that the bond is liquid, ask your broker about the time and price of the last trade. Illiquid securities may not be traded for several days or even weeks!
6. Understand All Costs
Find out as much as possible about any applicable fees and charges. How does your broker get compensated for transactions? What markups or markdowns can be applied?
7. Reinvest Coupons
Leverage the power of compounded interest. Set up a special account for coupons, so you will be less likely to spend this money. A bond fund will do it for you.
8. Don’t Try To Time The Market
Last but not least, stick to your investment strategy regardless of market fluctuations. Speculating on bond rates is a bad idea. Oftentimes, investors make decisions based on past rates dynamics, rather than the most likely future direction. Do not lose sight of your strategic objectives.
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