Bonds are types of loans where the receiving entity borrows money for a fixed amount of time and agrees to make regular interest payments before eventually paying back the principal in full. Some investors use them for dependable fixed income to balance the volatility of stocks, while others like how the price appreciation of more volatile bonds can come to the rescue when stock markets falter. Properly invested cash is also a form of bond and is far more dynamic than many investors appreciate. Bonds deserve a prominent role in any well-diversified portfolio.
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How they work
While the idea of a loan is pretty simple, bonds are a little more sophisticated under the hood than they may look on the surface. Bonds make money via two avenues — interest payments and price appreciation.
The interest payment (also called a “coupon” or expressed in terms of the percentage of the bond value as the “yield”) is made on a regular schedule determined by the individual bond and is a fixed amount for the duration of the contract. At the end of the contract the bond “matures” and you receive your original principal back in full on top of all the payments you received along the way.
However, one is not required to hold a bond all the way to maturity. The secondary market for bonds is extremely liquid, and the value of your particular bond will vary over time based on prevailing interest rates. Bond prices fall when rates rise and they rise when rates fall. And the longer the bond the more sensitive the price to interest rate changes. So bonds can make or lose far more money via price changes than they make via coupon payments, and it’s important to think of them beyond simple fixed income.
While investors have the option of purchasing bonds directly from the government or an individual company, a convenient alternative is to purchase a bond index fund. Index funds will manage all of the buying and selling of bonds for you and forward the interest payments to you on a regular schedule.
Bonds are typically distinguished by credit quality and the length of the contract (maturity). Lower quality bonds tend to pay more money to entice you to buy them, with the tradeoff that they have higher risk of default where they can’t pay your money back. Portfolio Charts focuses on the highest quality bonds available from various central banks with very little default risk, and bond data is always for your domestic home country.
While individual index funds may vary, the definitions are reasonably standard and the data here tracks bond ladders in the following ranges:
LT : Long Term — matures in 10-30 years
IT : Intermediate — matures in 1-10 years
ST : Short Term — matures in 1-3 years
BIL : Tbills / Cash — matures in < 3 months
Portfolio Charts collects domestic bond data for a variety of different countries. The data is based on the highest quality government bonds, and the terminology may vary by country:
Canada : Bonds
Germany : Bunds
United Kingdom : Gilts
United States : Treasuries
What the asset codes mean
You may find references to bond asset codes that combine country and type acronyms. For example, USA-LT represents long term treasuries in the United States and UK-ST represents short term gilts in the United Kingdom.
Purchasing a bond fund
Real-world index funds simply track the above index definitions. So to add a particular asset to your portfolio you just need to find an index fund tracking your desired index. The Index Funds list can help you find a fund for your portfolio, but here are a few additional tips:
– If you can’t find a good T-Bill index fund, try looking for a “treasury money market fund”. They operate the same way.
– In times of low interest rates, it’s common for some investors to substitute a short term bond fund for a T-Bill fund. They will have slightly better interest rates for only a little more volatility risk.
– Funds from different providers may have different trading fees at your individual broker. This can be especially important with short term bonds or T-Bills you may be depending on for cash. When possible, be sure to look for funds with low trading fees.