In the world of investing, stocks and bonds are the two major asset classes. Stocks are ownership in companies and can provide long-term growth and trading opportunities. Bonds are debt securities, where the bond issuer pays interest to the bond investor and the principal value at some point in time. A look at the benefits of bond investing is one way to show what types of people should have bonds in their investment portfolios.
Asset Allocation Considerations
The asset-allocation investment theory works on the principal that long-term returns depend more on what asset classes you own rather than the individual investments you purchase. The classic asset-allocation model determines portfolio percentages for stocks and bonds, with a strategy to rebalance the amount in each as values move up and down. An investor following an asset-allocation model owns bonds to participate in those time periods when bonds are outperforming the stock market. Bonds can provide stability and regular income during stock market bear markets.
Investment Portfolio Income
If you are an investor who wants or needs to receive income from your investments, you will want to have a portion or even a majority of the portfolio invested in bonds. A bond pays a fixed rate of interest and the principal value at maturity, which can be reinvested into another bond. Portfolio income can also come from stock dividends, but those dividends are not guaranteed and can be reduced or eliminated at the discretion of the payer. The different types of bonds allow you to put together a portfolio with a yield, tax and safety factors that work best for the investor's personal financial situation.
Reducing Investment Taxes
For high tax-bracket investors, municipal bonds are the one true tax-free investment choice. Municipal bond interest is exempt from federal income tax and interest from bonds issued in your home state are exempt for state income tax as well. An investor in a combined 50 percent tax bracket can earn an attractive taxable equivalent yield by investing in home-state, double-tax-exempt bonds. If you are in a high net-worth position, you may not need to shoot for large stock market gains, but instead want to generate tax-free income while keeping investment values secure.
Safety Over Growth
Bonds are the investment choice for those individuals who cannot or do not want to live with the volatility of the stock market. While stocks have produced larger gains than bonds over the long term, there are investors who cannot accept the downside risk of the stock market when it does decline. Bonds guarantee the repayment of the face or principal value at some point, and for the right investor that guarantee of principal is more important than trying for larger returns in the stock market.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.