Investing in bonds: what you need to know

Bonds are a way to strengthen an investor’s portfolio when used in combination with smartly selected stocks. In this article, we’ll explain what bonds are, share the difference between bonds vs stocks, list the types of bonds, and more – plus we’ll provide a review of the fundamentals of bonds as well as the Badgley Phelps approach to bond selection.

What is a bond?

A bond is a fixed obligation in which a person lends money either to a company or the municipal or federal government. In return for lending that money, the person generally receives regular interest payments on the loan, as well as the repayment of the principal when the bond matures.

What is the difference between bonds and stocks?

Stocks give investors partial ownership in a company and are traded or sold on the stock markets. Stock prices fluctuate and tend to reflect the consensus view of the future prospects of the company. Bonds are a loan from a person to a government entity or company that pay interest over time.

What are the types of bonds?

There are three main types of bonds including:

1. U.S. Treasury bonds, which are issued by the United States government.
2. Corporate bonds, either investment-grade or high-yield, which are issued by private and public companies.
3. Municipal bonds, which are issued by city, state, and county municipalities.

What are green bonds?

A green bond is very similar to a traditional bond except that the money must be used to fund projects aimed at helping the environment. There are both government and corporate green bonds. Some examples might be projects aimed at clean transportation, climate change, or solar energy.

Which are the safest bonds to invest in?

U.S. Treasury bonds are often considered to have extremely low credit risk. The reason they're the safest is that they are backed by the full faith and credit of the United States government.

Which are the riskiest bonds to invest in?

The riskiest bonds are high-yield bonds. They're also known as junk bonds. These risky bonds are more likely to default, and for that reason, we at Badgley do not focus our efforts looking at high-yield/junk bonds.

Why are bonds a good investment?

Bonds serve three purposes for a portfolio:

1. Capital preservation.
2. Generating predictable income.
3. Diversification, especially against a more volatile equity portfolio.

Historically, bonds have been shown to have low or even negative correlation with the stock market, so they can often act as a cushion against the ups and downs of the stock market.

Characteristics of short-term bonds

Short-term bonds often provide a high level of predictability and liquidity but usually with lower expected returns.

Characteristics of long-term bonds

Long-term bonds can provide higher expected returns and diversification benefits but often at the expense of increased volatility.

Why might someone sell a bond before it matures?

One reason an investor might sell a bond before it matures is because they need to fulfill a cashflow obligation. Another reason to sell a bond prior to maturity is relative value. For example, if an investor owns bond A but discovers bond B has more favorable characteristics with a higher yield, the investor will want to sell bond A and purchase bond B.

What factors determine a bond's price?

In the secondary market, some of the factors that influence a bond’s price are changes in interest rates, changes in the economy, credit quality, and supply and demand.

What is the firm’s approach to buying bonds?

At Badgley Phelps, client portfolios are managed as a separate account with a diversified mix of individually selected bonds. Most of our clients have balanced portfolios so we tend to focus on high-quality, intermediate-term bonds.  These bonds tend to provide the diversification benefits that we’re seeking in combination with the client’s equity allocation.

How do we evaluate bonds?

Bonds are evaluated by looking at the following factors:

• Maturity date
• Credit quality
• Yield of the bond
• How well the bond fits in with the rest of the bonds in a portfolio
• How the bond might be affected by changes in the economy

Bonds can be a valuable tool to help you achieve your objectives and they play an important part in a diversified portfolio. If you’re interested in talking with a financial planner about your portfolio, reach out today.