Bond 101 Primer

I tweeted today about a Bond 101 Primer courtesy of PIMCO. Well worth a read.

When we reach asset classes in this blog’s investment series, we will go into bonds in detail. A good article, but the PIMCO primer illustrates why I am trying to build up some core investment knowledge before tackling the assets, strategies, and tactics. It is a much better read if you understand diversification, correlations, hedging, and such.

Bonds Get a Lot of Questions

I mention it now as bonds are usually a big question from clients.

Namely, “Why should we invest in an asset class (bonds) that tends to offer weaker expected returns than other classes (e.g. equities)? Shouldn’t we want to put our money in assets with the best expected returns?”

I would not disagree with either question. So why should you invest anything in bonds?

Non-Return Bond Benefits

I like bonds in portfolios for a variety of reasons.

Yes, you can get real returns from bonds, so they are not a waste of capital (though they can be in certain economic conditions). You can also generate substantial capital gains (or losses) from bonds (again, depending on economic conditions). So there are possible returns from capital as well as interest.

But I like bonds in client portfolios for non-return benefits.

Bonds often provide higher stability and certainty of returns than equities. Over time, bonds may earn less than equities, but your risk level should be lower. Preservation of capital may outweigh potential returns for many investors. And, as you approach retirement and plan to live off your savings, having a known income stream is important.

Bonds often are less than perfectly correlated with equities. This enhances portfolio diversification, a desired result.

Bonds may provide hedging opportunities which can be beneficial.

Bonds come in multiple sub-classes in a variety of currencies. Depending on your risk appetite, some bonds may offer potentially lucrative returns versus equities. Tactical bond strategies within the asset class alone can increase returns, reduce portfolio risk, and enhance hedging. You can purchase plain vanilla buy and hold until maturity bonds. Or you can engage in many varied tactics. Bonds offer all things to all investors and can achieve a wide variety of objectives.

I think most investors, even those with extremely long investment time horizons, can benefit with a percentage of bonds in their portfolios. Obviously, the exact proportion fluctuates between individuals, as well as over time for a specific investor, based on unique and ever-changing personal circumstances.

One Other Note

I do suggest taking a look at the PIMCO piece. If you understand all the terminology and concepts, great.

If not, do not worry. The article illustrates what I am attempting to do with my blog posts. Over the next little while, we will lay a solid foundation of investment concepts. Asset correlations, diversification, hedging, etc.

By the time we get into the properties, advantages, and disadvantages of various asset classes, you will easily follow the points. But without the groundwork, probably not as much value diving right into asset class pros and cons.

For example, I tweeted that I tend to favour using bond ladders for the average investor. PIMCO touches on ladders. But when we finish the core concepts and get into fixed income, you will better understand WHY bond ladders may be useful in your portfolio strategies.

To me, it is the understanding why something should be utilized that makes investors successful.

Hopefully, over time, we achieve that together.