Investing in bonds is just one way to diversify your investment portfolio. After all you should not put all your eggs in one basket. Bonds are a great investment if you want a regular income stream. Many people enjoy receiving the added income while preserving their initial investment. When it comes to investing in bonds, there are actually many different strategies that you can employ.
If you are an active investor and you want maximize the returns on your investment, you should learn about these different strategies and choose the one that is best suited to you and your investment style. Some of the most common bond strategies being utilized to help the investor achieve their desired result include bond ladders, barbells, bond swap and bullets. This article will take a closer look at these bond strategies.
1 Bond Ladders
One of the factors that a bond investor must consider is the maturity date of the bond. Short term bonds are the safest, but they generally have low returns. Those with longer terms will have higher returns but there is a greater risk involved. If you want to mix and match, the best thing to do is to create a bond ladder. The total investment amount is divided equally, and you purchase bonds with different maturity dates. The shortest maturity date is the bottom rung of the ladder while the bond with the longest maturity date is the topmost rung of the ladder.
The main advantage of a bond ladder is that you will have the flexibility to adjust the flow of income depending on your financial requirements. You won’t get locked on a single bond for a certain period or time. However, investing in individual bonds pays at a fixed rate, and there is a risk of that rate being lower than the marketplace. A bond ladder also tends to have high management fees, since each bond that you purchase will have its own management fee.
A barbell strategy makes use of extremes. You only invest in short-term and long-term bonds. Those usually have bond maturities of five and twenty years. A major advantage of barbells is that it benefits from a rally of your long term bonds while hedges your outright position. The long term bonds would have offer high returns while the short term bonds will allow you cash in part of your investment more quickly and reinvest in another instrument if the bond market becomes unattractive. A barbell behaves like an intermediate bond. If you are the type of investor that usually buys and then holds, this is not the strategy for you because a barbell strategy can sacrifice yield.
A bullet strategy is buying bonds that have the same maturity date in a staggered manner. The bullet strategy is appropriate when you already know when you need the money. For example, your kid will going to college in ten years or you will be purchasing a retirement home in a decade. Using a bullet strategy, you will purchase different bonds within the next four years. Each one will have varied terms, but they will all mature at roughly the same time, giving you money to buy that retirement home or pay for your child’s tuition.
This type of strategy protects you from being exposed to fluctuating interest rates. The disadvantage of this strategy is that it does not offer a regular income stream. It’s a onetime big time deal. This may not be for you if you want to receive your returns in a predictable manner.
4 Bond Swap
A bond swap occurs when you sell a bond and use the cash generated to immediately purchase a bond. This is quite an easy thing to do with bonds because you can usually find two bonds that are similar enough to each other. This is usually done to meet your financial goals faster. A bond swap can increase the quality of the bonds that belong to your investment portfolio.
Tax swapping is a specialized form of bond swapping wherein you swap the bonds that are selling below their amortized buying price or bonds that have capital gains that can be offset if you do a tax swap while they are still trading at a loss. Tax swapping can be complicated and involve federal tax laws. You have to consult a tax advisor before proceeding with a tax swap.
These are just a few of the many strategies that you can employ when investing in bonds. Which one of these bond strategies suits your investment style and financial plan?