A bond is just a promise, and fraught with all the problems that
Think "bonds," and you probably think "safe," "reliable" -- in
a nutshell, "boring." But that is only half the story. Bonds can
provide a worry-free stream of income. But this class of securities
includes a wide array of instruments with varying degrees of risk
and reward, some of which offer gains -- or losses -- comparable
to those of any white-knuckle stock.
Used improperly, bonds can really mess up your financial life.
Handled with care, however, bonds are among the most valuable
tools in your investment kit. Here are some of the benefits bonds
To enjoy these benefits, though, you need to know how bonds work
and how to buy them. That's what this lesson is about.
- Diversification. Large company stocks have posted compound
annual returns of around 11.3% since 1926, versus 5.1% for long-term U.S.
government bonds, according to Ibbotson Associates. But while stocks
have returned more than bonds over most of this decade, they are
also more volatile. Combining stocks with bonds will net you a
more stable portfolio.
- Income. Because bonds pay interest regularly, they
are a good choice for investors -- such as retirees -- who desire
a steady stream of income.
- Security. Next to cash, U.S. Treasuries are the safest,
most liquid investments on the planet. Short-term bonds are a good
place to park an emergency fund or money you'll need relatively
soon -- say to buy a house or send a child to college.
- Tax savings. Certain bonds provide tax-free income.
Although these bonds usually pay lower yields than comparable taxable
bonds, investors in high tax brackets (generally, 28% and above) can
often earn higher after-tax returns from tax-free bonds.
Next: How bonds work