Benefits and Risks Associated with Bonds

While bonds traditionally earn lower returns than stocks, that does not mean there isn't a place in your portfoliofor bonds. The most common reason for investors to purchase bonds are below:

• Diversification - Bonds tend to be less volatile than stocks and can therefore stabilize the value of your portfolio during times when the stock market struggles. Having a combination of both types of investmentsover the long term can often provide comparable returns with less risk than a portfolio devoted to only one type of investment.
• Stability - If investors know they will need access to large sums of money in the near future-for example, topay for college, a home, etc.-then it does not make sense to place that money in a highly volatile investment like stocks. Because the majority of the return on bonds comes from the interest payments (the couponpayments), fluctuations in the price of a bond will have little impact on the value of the investment.
• Consistent Income - Unlike stock dividends, coupon payments are consistently distributed at regular intervals. Individuals seeking this consistent income might find bonds a better alternative than the dividend payments some stocks offer.
• • Taxes - Payments from some bonds are exempt from federal taxes. For individuals in high tax brackets, these investments are often an excellent vehicle for their portfolio .
  Bonds are often called "fixed income" investments, but don't let that term fool you. Bonds are not riskless investments. While they are usually considered much safer than stocks, bonds can still lose value while you hold them. Here is a brief look at some of the risks associated with bonds:
  • Interest rate risk - Bond prices are inversely related to interest rates, so if interest rates increase, the price of the bond will decrease. The interest rate on a bond is set at the time it is issued. Generally, the coupon will reflect interest rates at the time of issuance. However, if interest rates increase, people will be unwilling to purchase the bonds in the secondary market at the earlier rate. For example, if the coupon is set at 6%and interest rates in the market are at 7%, the interest rate on the bond is well below what you could get from a different investment. Therefore, the price of the bond will decrease so that the capital appreciation will make up for the difference in interest rates.