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April 16, 2000
Today everyone is feeling the pain of a volatile market. Even if you don't own the "new economy stocks" (technology and Internet stocks), the old economy stocks are also down. You've suddenly realized the importance of asset allocation (see related article) and have decided to diversify a portion of your funds in some very conservative, less volatile investment vehicles. In addition to your cash investments (CDs and money market), consider investing in bonds. Although most people think bonds are only good for older people, bonds play an integral part in helping you maintain proper diversification, can offer a steady stream of interest income, can provide some tax-free income and can provide a "safe haven" from sharp drops in the stock market.
Bonds are simply a form in which businesses and government entities can borrow money to help pay their expenses. By issuing a bond, the business or government entity promises to pay investors a fixed amount of interest for the use of their money. Additionally, the principal balance will be paid at a designated time (called a "maturity date").
A good way to invest in bonds is through a bond fund. Bond funds usually require less money up front and since bond funds own many different bonds, you get more diversification in your portfolio. As an investor in a bond fund, you don't actually own the bonds, but shares in the bond fund. You will receive dividends (your share of the fund's earnings) based on the interest income generated from the bond holdings and the number of shares you own. Because bond funds invest in several different bonds all with different interest rates and maturity dates, you don't get your investment back at a particular point in time the way an individual bond does. Additionally, your interest rate will vary because the fund does not earn interest at a single rate, but instead, reflects the combined rate of all the different bonds it invests in. Although investing in bond funds may result in addition expenses such as broker's sales loads and operating expenses, you get the benefit of an experienced manager professionally managing your bond investments.
Like other investments, bonds do carry a risk. Although the issuer of the bond promises to pay both the interest and principal due, there is no guarantee they will. This is known as credit risk. To help you determine a particular bond's credit worthiness, look up the bond's rating established by either Standard & Poor's and Moody's. Bonds with the strongest issuers carry a rating of AAA or Aaa and the lowest rating for a bond that is not in default is C. Keep in mind that high credit ratings do not guarantee payment of principal and interest and that a bond's credit rating can change.
Although you can't time the market's ups and downs, proper asset allocation and a long-term investment horizon will help you beat the odds. Check out MsFiscallyFit's bond fund review - Harbor Bond Fund.
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