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Investment Basics: Don't forget about bonds

You should consider investing in bonds for both income and stability. In any given year equity markets could appreciate in value by 30 to 40 percent or decline in value by the same amount. Bonds fluctuate far less. Bonds also pay interest on a regular basis and thus investors will receive a cheque each month or quarter. As with any investment, it is easy to get lost in the minutiae and with bonds the details come from some of the arithmetical calculations that determine the yields, returns, and risk of a bond. Here are the basics.

Bonds offer a fixed amount of interest (the coupon rate), until a fixed period of time (the maturity date) at which point the denomination, also called the face value, is repaid and the interest payments stop. Bonds are issued by the federal, provincial, and municipal governments, and by a wide variety of corporations. In general, corporations have to offer higher coupon rates to sell their bonds. Maturity dates range from 1 year to more than 30 years, with higher coupon rates being associated with longer periods to maturity, to compensate for increased risk. Long-term bonds tend to rise and fall in price more dramatically than do short term bonds; these bonds are more susceptible to movements in interest rates.

In addition, bonds that provide higher coupon payments will fluctuate less than bonds that pay lower coupon payments. Staggering the maturity dates of bonds, which mixes bonds with short, medium, and longer periods to maturity, as well as mixing the institutions issuing those bonds (to include governments and some corporate bonds) will allow you to build a diversified bond portfolio). Bond trading is done between dealers, which means that you won't be able to view a complete auction market and its available quotes via the internet or even the newspaper. These same dealers will be able to supply accurate calculations of bond yields and the current price. Investors who invest in bonds directly as opposed to investing in bonds through a mutual fund will save on fee; saving 1/2 of one percent can make a big difference to your net worth. Investors who want diversification and active management could consider a bond mutual fund.


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