At Henssler Financial, our philosophy states that funds needed within 10 years should be invested in high quality corporate, municipal bonds or U.S. Treasuries. Though the stock market has outperformed all other investment vehicles over time, attempting to beat the market in less than a 10-year window could be quite risky.
Types of Bonds
- Municipals: Bonds issued by state and/or local governments.
- Treasuries: Bonds issued by the federal government.
- Corporates: Bonds issued by public and private corporations.
Risks of Bond Investing
Interest Rate Risk
Bond prices and interest rates have an inverse relationship; interest rates go up, bond prices go down. Likewise, if interest rates decline, bond prices will increase.
Default Risk
The risk that the issuer will be unable to meet interest payment requirements and/or fail to refund the principal investment.
Liquidity Risk
This risk is created by the uncertainty surrounding the secondary markets. In some instances, it may not be easy to convert your bond into cash prior to maturity.
Call Risk
The risk that the bond issuer will refund the principal prior to maturity. In many instances, a bond contract will allow the issuer to prematurely buy back its debt should conditions warrant. If interest rates decline, an issuer operating under a call provision may exercise that right and refund the bond by issuing lower interest rate debt.
Strategies for Managing a Bond Portfolio
Laddering
Match maturity dates with your liquidity needs.
Quality
Invest only in high quality issues. Despite the relatively low risk in AAA rated corporate bonds, the differential as compared to U.S. Government bonds is minimal. The tax benefits and security will more than compensate. Choose Municipals rated AA or better and backed by an insurance agency. All U.S. Treasury Securities are backed by the full faith and credit of the United States Federal Government.
Holding Period
Hold your bonds until they mature to avoid interest rate and liquidity risk.
No Calls
Choose bonds without call provisions. U.S. Treasuries do not have a call provision. Some municipal bonds have call provisions, but others are available without them.
With interest rates at near historic lows, it has been a difficult time to find a 10-year bond paying the interest rates we seek. In markets like this, we often buy a short-term security with 10-year money to wait out a period of low interest rates. When the short-term bond matures, hopefully, interest rates are higher and we are able to buy longer term bonds to match our clients’ liquidity needs. Short maturity bonds are not as likely to experience price deflation in rising interest rate environments as longer maturity bonds.
We also prefer to hold individual bonds rather than bond funds, because most bond funds never mature. With a bond, if you buy a $1,000 10-year Treasury bond, you know in 10 years you should receive $1,000 from the federal government. However in a bond fund, in 10 years, if interest rates were significantly higher, the value of the bonds in the bond fund likely declined and you stand to lose part of your principal. We may look to short-term bond funds for immediate liquidity needs or emergency reserves, but we generally prefer to avoid bond funds. Bond funds also have management fees and may carry lower quality bonds in their portfolio.
At Henssler Financial, we believe you should Live Ready, and that includes understanding the role bonds should play in your portfolio. If you have questions on your fixed-income securities, the experts at Henssler are here to help. Contact us at 770-429-9166 or experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
