What Bonds are Good at
And where you can use them
In my previous post I discussed Bonds, and was quite critical about them.
Today, I wanted to discuss the good things about bonds, and where they may fit in an investment portfolio.
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Do Bonds have a place in a Portfolio?
If you like bonds despite their drawbacks, you’ll be happy to know that the answer to this question is a resounding YES!
Bonds do have a place in some (but not all) portfolios!
The key thing to understand is that despite the fact that Bonds have all of the downsides of equity investments, and few advantages in terms of risk/reward compared to other options, bonds do have some unique characteristics that can make them attractive in certain circumstances.
The key characteristic that most bonds (and I do mean bonds, not bond funds) have that stocks do not have is the concept of an expiration date.
At a certain date, a bond will pay its final coupon, and will return the invested capital to the bondholder.
This might seem like a small detail to focus on at first, particularly for long term investors who will immediately reinvest the cash into other bonds with similar risk profiles (as happens in most bond funds).
But this expiration date is very important, because it gives you the investor the certainty that unless the bond issuer goes bankrupt, at a certain date you will have available a specific amount of capital.
How can you use this?
Well, let’s imagine you’re saving up some money for a downpayment on a house…
You could put the cash that you’re gathering up into your checking account…
But downpayments can be pretty big, and so they take a while to gather up.
If you’re going to take 5 years of work and grind to gather enough cash for a proper downpayment for a house… Do you really want that cash doing nothing for you during that time?
Of course not, you’d like to have it invested somewhere, returning some income!
This is where bonds come in, you can buy individual bonds with expiration dates on the exact day that you need that capital to be in your bank account ready to be used on the house!
Yes, you won’t be able to make as much cash as if you’d invested in an equity index fund, but you will be able to be certain that on a given date you will have X amount of dollars in your bank account.
The return you get from coupons, even if it’s not as profitable as an equity stake, will still be substantial, and you will be able to use it to increase your downpayment (and therefore reduce your mortage!)
This same thing applies to any other reasonably short term need for cash, which you do not want to just leave sitting in your bank account.
And importantly it applies only to bonds, not bond funds, because bond funds reinvest the capital on bonds of varying expirations you do not have the “guarantee” that the principal will be there when you need it.
Stick to instruments with specific and short term expiration dates, and you will have a fair and reasonable use for bonds!
What do you think? Do you have any bonds?
Let me know in the comments below!