Bonds #13: Ready, Set, Go!

At the start of this series, we saw the advantages of bond investing, and highlighted four specifics:

SAFETY

DIVERSITY

INCOME

GROWTH

Then, we’ve explored the types of risk that bond investments have, to various degrees:

Credit risk

(the likelihood of default from the bond issuer)

Market risk

(ups and downs due to interest rate gyrations

Reinvestment risk

(what to do with your bond interest or maturities)

Inflation risk

(will your returned principal and interest keep pace with inflation)?

And, we’ve looked at the major types of bonds, and seen their differences, advantages and risks:

Treasury bonds

Corporates

Zero Coupons

Municipals

Government Agencies

Agency MBS (mortgage-backed securities)

Eurobonds

Globals and Yankees

So, let’s assume that you have identified your objectives and risk tolerance. For example:

You know if you can reinvest your income for the time being or if you need it for living expenses now.

You know that you could never sleep without the AAA government-guarantee of Treasury bonds.

You want to buy and sell your bonds actively, so you are looking at Treasuries to keep the trading expenses lower.

You decide that you would rather have the additional yield (1 to 2 % extra over Treasuries) of bonds issued by corporations, as long as they are investment-grade.

You want some bonds in your balanced portfolio, but as you are under 40 years (lucky dog!) you are comfortable with high-yield “junk bonds”.

How do you put these plans into practice?

How do you know when to invest?

Should you buy a long or short maturity bond?

Should your buy a variety of bonds at the outset?

Or buy one type of bond and maturity at a time?

What should your portfolio look like when you’re done?

How can you keep income steady, month to month?

How can you keep it steady, when bonds mature?

Should you sell a bond if interest rates go up, so you can buy one at a higher yield?

In the coming weeks, we will come up with a game plan for some of the most common objectives.

To the first question, THE BEST TIME to invest,

the answer is NOW.

READY!

The best FIRST investment is to pay off credit card bills. The high rate of interest and the temptation to pay off only the minimum each month combine for a poor use of money, since you pay for your purchases over and over. (Not clever, even if the item was on sale!) Add up your balances each month, and get the satisfaction of seeing them go down. It is a terrific incentive NOT to buy unnecessary items.

SET!

SECOND, build up a cash fund. These savings cover employment, family or medical emergencies. Have a few months’ expenses in a bank or credit union savings account, a money market fund or in short-term Treasury bills.

GO!

Add to the cash fund until you have an extra two or three months of expenses accumulated. That should be enough to get you started in investments.

If you have received a lump-sum payment (inheritance, life insurance payment), determine if you can reinvest income, and for how long. Will you need to use up principal? How much, how soon?

With these answers, you can build your portfolio!

Next week, we’ll look at the classic ladder structure.