In the midst of a bullish stock market, it can be hard to hear that calm voice of investing reason telling us that asset allocation is an important aspect of prudent, long-term investing.
Don't be tempted by higher
yields offered by bonds with
lower credit qualities.
Depending on your goals, age, total asset mix and tolerance for risk, your portfolio should contain a mixture of investments including stocks, bonds and cash. This investment mix is referred to as your asset allocation. It’s often during long bull markets that an asset mix can get out of sync and calls for rebalancing. When investments in stocks have been rising, rebalancing generally means considering shifting some assets back to bonds.
Here are 7 tips to consider before you invest in bonds or bond funds:
- Don't reach for yield. Sometime referred to as “yield chasing,” this tends to happen when interest rates are low or have recently declined. You may think you’re not earning a high enough rate of return on your investments (or that you have become accustomed to with stocks). Don't be tempted by higher yields offered by bonds with lower credit qualities, or focus only on gains that resulted during the prior period. Never forget: With higher yield comes higher risk.
- Assess your investment’s risk profile. Different bonds and bond funds, like stocks and stock funds, carry different risk profiles. Always know the risks before you make an investment in any investment product. It's a good idea to write down the risks associated with a product so they are all in plain sight.
- Read the prospectus of any bond, bond fund or balanced (mixed) fund closely. In a bond or balanced fund, pay particular attention to the parts that discuss the bonds in the fund because the name of a fund may not tell the whole story. For instance, not all bonds in a government bond fund are government bonds. Also, make sure to pay attention to the prospectus’s discussion of the fund’s fees. Individual bonds also have prospectuses, which derive information from a bond's indenture, a legal document that defines the agreement between bond buyer and bond seller. Ask your broker for a copy of the prospectus or indenture to read it.
- If you're buying individual bonds, locate a firm and broker specializing in bonds. A good place to start when shopping for an investment professional is to ask friends, family and colleagues who already invest for the names of people they’ve used. But don't stop there, make it a priority to only work with registered firms and individuals. Talk to a number of brokers before making your choice, and make sure he or she knows your objectives and risk tolerance. Always check out firm and broker credentials and disciplinary histories using FINRA BrokerCheck before handing over your money.
- Ask your broker when, and at what price, the bond last traded. This will give you insight into the bond's liquidity (an illiquid bond may not have traded in days or even weeks) and competitiveness of the pricing offered by the firm. You can also look up information about bonds on FINRA’s Market Data Center by entering the name of the bond or CUSIP number.
- Understand all costs associated with buying and selling a bond. Ask upfront how your brokerage firm and broker are being compensated for the transaction, including commissions, mark-ups or mark-downs, and any other transactions costs or fees associated with bond transactions. To compare costs related to bond funds use FINRA’s Fund Analyzer.
- Don't try to time the market. Avoid speculating on interest rates. Too often investment decisions rely on where rates have been rather than where they are going. Instead, stick to the investment strategy that will best help you achieve your long-term investment goals and objectives.
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