Grow your wealth by learning about different bond investment techniques.
Bond Investment Strategies for Different Types of Investors
What Is a Bond?
When it comes to a bond investment, there’s no one-size-fits-all solution. If you’re looking to create a well-rounded and diverse bond portfolio, you may want to explore various strategies.
First, though, what are bonds, and how do they work?
Bond Definition: Bonds are a form of fixed-income securities that function like debt obligations.
Usually, large companies, such as corporations and the government, provide bond offerings to the public. When you buy them, you lend your money (loan) to the entity.
Like a regular loan, the entity then needs to return the money to you together with the bond proceeds depending on the interest rate.
Since a bond is a fixed-income asset, you can expect the return of your money, together with the bond proceeds, by a particular date. Bonds can also pay on different dates, but you usually know when the bonds mature.
Here are a few reasons why a bond can be a good way to increase wealth:
- It may need a lower capital than other types of investment, such as real estate.
- Since it has a specific maturity date, investors can better manage their cash flow.
- There are different types of bonds, which may appeal to a broad range of investors.
- If you apply smart investment strategies, it can grow your money fast and efficiently.
12 Bond Investment Strategies
Whether you’re still thinking of bond investing or planning to grow your existing investment, these strategies can be useful:
1. Buy-and-Hold Bond Investment
Also called passive investment, the buy-and-hold bond investment strategy involves purchasing bonds and holding them until they mature.
At that point, you can cash out the bonds and use the income. You can also reinvest into more bonds.
This strategy works for both premium and discount bonds. Investors do not have to worry about changes in interest rates, they only need to buy the bond and hold on to it. This type is ideal for people trying to minimize investment complexities and avoid transaction fees.
Before buying a bond to hold, look at its coupon interest rate. When you multiply it by the face value of the bond, you get your annual interest payment.
It is important to remember, though, that not all bonds are a sure thing. You have to consider the creditworthiness of the bond issuer and the credit quality of the bond.
The higher the credit rating, the more secure your investment is. If you can handle a low credit rating, you can enjoy a potentially higher yield.
There are different credit rating agencies, which include Standard & Poor’s, Moody’s, and Fitch. These agencies will provide a credit rating symbolized by letters. The actual designations can differ among the agencies, but AAA is usually the highest for investment-grade bonds.
2. Bond Laddering
Another type of passive bond investment, laddering involves purchasing multiple bonds with different maturity rates.
Here’s an example. If you have $100,000 to invest, you may buy 20 bonds worth $5,000 each with maturity dates that are every 6 months over the next 10 years. With this bond investment strategy, you receive a constant flow of cash because of regular payments.
If you plan to reinvest the money you earn, you can manage different market conditions.
To explain, imagine you invest all $100,000 in a single bond that matures in 5 years. At that point, though, if interest rates are low, if you reinvest, you will not get much money back.
In contrast, if you receive the income at different times, you can have the opportunity to invest in bear and bull (high and low) bond markets.
3. The Barbell Strategy
Similar to the ladder strategy, the barbell bond investment strategy involves purchasing bonds at different maturity rates.
Instead of receiving the maturity rates in an even fashion, you buy only short- and long-term bonds. It’s like a barbell because the bonds mature on either end.
There are no intermediate maturity dates. This allows you to take advantage of the attractive coupon rates associated with many long-term bonds.
Because you also have some short-term bonds, you can look forward to earning some money right off the bat. Then, you can use the money for expenses until your other bonds mature. You can also reinvest it when the interest rates are the highest.
4. Bullet Strategy
This is similar to the ladder and barbell strategies. This bond investment strategy requires that you to reinvest the money you earn from your bonds.
Instead of focusing on different maturity dates, you buy bonds that all have the same maturity date, but you do so at different times.
The bullet strategy allows you to take advantage if interest rates rise. For instance, you may buy a bond that matures in 10 years. Then, the next year, you buy a bond that matures in 9 years.
If the interest rates rise between those two purchases, you increase your potential yield.
5. Indexing Bond Strategy
With an indexing strategy, you invest in a group of bonds with the goal being that the return matches a certain index.
For instance, the portfolio may use the Barclays Capital US Aggregate Bond Index. It may also use another index weighted by a certain amount.
Whether you have corporate bonds, tax-exempt municipal bonds, or something else, the account administrator rebalances the makeup of the bonds to ensure they match the index.
The chief advantage of this investment strategy is it provides a reliable rate of return. The downside is it needs a lot of bonds to average out to the index.
Depending on the setup of your account, you may also face administrative fees according to the bought and sold bonds to rebalance the rate of return.
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6. Immunization Bond Strategy
This bond investment strategy draws its name from the fact it is not as complex as most of the others. In fact, banks, insurance companies, and pension funds often use this strategy because it is without much of the challenges that others come with.
It is similar to the buy-and-hold strategy in that you buy a bond and keep it until it matures. However, unlike the buy-and-hold strategy, you do not reinvest the funds. Instead, you focus on maturity dates that provide the funds exactly when you need them.
This bond investment strategy is ideal if you have a specific need for money at a specific time. For instance, if you want money to pay for your child’s education or to use during retirement, you may want to consider immunization.
7. Interest Rate Anticipation
This is an active bond investment strategy. Interest rate anticipation involves buying and selling bonds according to their projected interest rates.
The idea is to focus on the bonds with the highest interest rates. This strategy often involves buying over-the-counter bonds not traded on the major exchange market.
You usually have to buy these bonds through a dealer network. They include pink sheets, asset-backed securities, and debt securities such as mortgage-backed securities.
With this strategy, you often end up buying secondary bonds. As a result, you have to pay attention to how supply and demand affect their value.
To give you a simple example, imagine you want to invest in a government-issued municipal bond. The current offering has a 6% yield, but the bond the municipality sold last year had an 8% rate of return. Because you are focusing on high-interest rates, you attempt to buy the bond with the 8% rate of return on the secondary market.
Of course, because you are not the only investor using this strategy, the demand for this bond can increase. In the process, the price of the bond increases beyond its face value. Because the bond is more expensive, this drops its yield.
Before you buy, you need to make sure the drop in value does not make this bond less valuable than the bond with the 6% yield.
8. Using Bonds to Balance Out Stocks
Typically, the stock market tends to have higher volatility than the bond market. With bonds, you can often look forward to a specific rate of return.
This is never the case with stocks.
That is why some people use bonds to balance out the complexities of stock market investments.
Often, these markets tend to move in different directions. When the stocks are falling in value, bonds are rising and vice versa. This investment strategy underscores the importance of diversification.
Diversification is always essential when you are investing. If you want it to be at the heart of your bond investment strategy, though, you need to invest in a variety of bonds types.
You may want more secure bonds, such as municipal bonds, but you may also include some corporate bonds.
As a general rule, secure bonds tend to have low, but assured, yields. Less secure bonds have higher yields but a greater potential for default.
If you are trying to maximize your income by investing in high-yield bonds, you need to diversify to protect your portfolio.
10. Tax-Centered Investments
You may also want to pay attention to tax implications when choosing your bond investment strategies.
Different types of bonds can face different taxes. For instance, treasury bonds are taxable on the federal but not on the state or local level. If you are in a state with high-income taxes, you may want to check out those bonds.
Municipal bonds may not have a federal tax. In some cases, they even avoid state or local taxes. That makes these bonds even more attractive than federal bonds to some investors.
In other cases, you can reinvest the money you earn from your bonds. This way, you can avoid capital gains tax.
Some investors sell bonds at a loss on purpose. Then, they use those losses to counteract capital gains they have from other bonds.
11. Mutual Funds
Mutual funds are one of the bond investment strategies for beginners and existing investors who don’t have a lot of money or know-how.
In a mutual fund, a company pools the available resources such as investors and their money to buy different kinds of assets. These can range from bonds to stocks.
People then earn money in different ways. One is through distribution such as dividends or earnings from capital gains. The other is earning a profit when the market price of the asset rises.
Mutual funds do have a lot of fees, but the investors can benefit from a managed portfolio. It reduces the burden of monitoring the performance of the asset. It also makes what could have been expensive assets more affordable since the investors have a share of the costs.
An ETF, which stands for exchange-traded fund, functions like a mutual fund. It also has an investment manager and pools resources from shareholders. There are notable differences, though. For example, ETFs tend to have a lower investment premium than mutual funds.
A bond ETF also differs from a traditional bond in that individual bonds have a fixed maturity date while bond ETFs don’t. Instead, they are always ready for maturity due to the number and the types of bonds included in the pool. This means it doesn’t guarantee income, but you also don’t need to wait when you will receive coupon payments.
Bond investing takes a lot of work to understand but so does investing in general. Due to this, you may not want to do it all on your own. To safeguard your investments, you may want to get help from an investment professional.
Have you tried investing in bonds? What are your bond investment strategies? Share your experience in the comments section below!
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Editor’s Note: This article was originally published on July 19, 2018, and has been updated for quality and relevancy.