The role of bonds in your investment portfolio

Bonds have been one of the oldest investment vehicles that have stood the test of time. Investors have seen bonds as one of those no-brainers fixed-income investments they can rely on for stable returns.

Bonds are essentially a form of debt used by companies or governments to raise funds. The company/government that is issuing bonds is the borrower, while the investor is the creditor or bondholder.

The bond has a maturity date, which is the day when the issuer of the bond pays back the principal amount to the investor. Throughout the life of the bond, the issuer pays the investor an interest at a predetermined rate. This interest is known as the coupon and is expressed as a percentage of the bond’s face value.

The Bonds are generally categorised as short-term, mid-term, or long-term, based on their maturity periods.

What are the benefits of bonds?

Adding bonds to the portfolio gives investors a predictable income stream. Bonds pay interest at a regular interval, for instance annually or bi-annually.

If bonds are held till the maturity date, bondholders get back the entire principal amount along with the unpaid interest earned. Additionally, bonds can be sold in the secondary market at demand-driven prices, depending on how attractive the product is in the ongoing market conditions.

What is the role of bonds in a portfolio?

Investing in bonds is considered vital to maintain a balanced portfolio because of multiple reasons as outlined below:

1. Capital preservation: Allocating a portion of your income in bonds for long-term investments can help you preserve your capital as it is an extremely low-risk product. The principal value of a bond is returned to an investor in full at maturity. Investments in bonds, therefore, serve the dual purpose of capital preservation for risk-averse investors who are still actively using that money to make further money.
2. Diversification: Bonds are seen as a defensive asset class as they offer more predictable returns and are not as volatile as some other asset classes such as stocks. Therefore, bond diversification helps in reducing overall portfolio risk.
3. Income generation: Smart bond investment strategies can help investors generate regular income in the form of coupon payments. This income can be further reinvested or used for meeting expenditures by investors.
4. Capital appreciation: In stocks vs bonds debate, stocks always get points for the kind of opportunities they present for capital appreciation. Surprisingly, bonds also offer the scope of capital appreciation if investors sell them in the secondary market at the right time. Normally, bond prices can rise in the market if the coupon rate they fetch exceeds the interest rate prevailing in the ongoing policy rate regime. Selling bond holdings prior to maturity, can, therefore reap handsome returns if done at the right time.
5. Go-to instrument during slowdown: Bond investment strategies could probably withstand an economic slowdown as slower growth usually leads to lower inflation, which makes returns on bonds more attractive. Hence, it can be seen as an evergreen investment avenue, especially when compared with stock market returns that may fall in negative during tough economic times.

In conclusion, it could be a wise decision to add bonds in an investment portfolio if you are looking forward to balancing market fluctuations with a more stable savings instrument. Benefits of bonds also include diversified risk exposure and predictable returns, making them a smart choice for wise investors.