As many of you know we use quite a few individual bonds in your investment portfolio. We buy a wide variety of bonds differing in maturity, tax status, and more based off what makes sense in your financial picture.
What is the purpose of using all these individual bonds and what role do they play in your portfolio?
Individual bonds provide diversification from the stock market and provide stable income streams for your investment portfolio. As our wise, retired investment manager Tim used to say, “Bonds are the ballast of the portfolio.”
Individual bonds are held to maturity. This means you get back your initial investment (your principal), and you also collect interest payments along the way. The bonds we purchase are very high quality (strong credit ratings), and the majority of the bonds are insured, meaning your principal is protected.
Recently, changes in interest rates negatively affected bond prices which caused them to appear red (at a loss) on your statements. Should you be concerned with these declines in bond prices?
The short answer is no.
Interest rates and bonds have an inverse relationship. If interest rates go up, the value of your current bonds will go down. Likewise, if interest rates go down, the value of your current bonds will go up.
What do the “losses” on your statement mean? The bond price fluctuates with changes in interest rates. The price you see on Fidelity represents what price you would receive if we sold your bond early. Since we never sell your bonds, the price you see on Fidelity is not relevant. When the bond matures, you will get your principal back and you’ve collected all that beautiful interest along the way.
The long and short of this? You can simply ignore the losses or gains showing on individual bonds on your statements! Rest easy knowing that the bonds are doing their job and acting as your safety net along the way.
Why do we use individual bonds as opposed to just using bond funds? Using individual bonds allows us to lock in good interest rates for a longer period of time. With interest rates at near multi decade highs, you’ll be excited that you own these bonds when interest rates start to decline. As the bonds mature, Brett will look at reinvesting or using the proceeds to help fund your cash flow needs.
We use bond funds in addition to bonds for a couple of reasons. Bond funds are easier to sell than individual bonds. The proceeds can be used for cash flow needs or rebalancing. Bond funds come in handy when you have an unexpected expenditure such as a dream car or an opportunity for a once in a lifetime vacation! Bond funds can also allow us to take advantage of the cheaper prices in the stock markets if we see a pullback.
In summary, bonds do their job by funding cash flow needs, adding diversification, and serving as the ballast in your portfolio. I am always happy to chat and answer questions you may have about the bonds in your portfolio!