What we think about bond investing
- While stocks are the driving force behind long-term portfolio growth, bonds—which typically fluctuate far less than stocks—should be included in most portfolios to help temper stocks' short-term volatility.
- Broad diversification of bond holdings—in terms of credit quality and interest rate sensitivity—helps to reduce risk. Investors may also choose not to diversify (within limits) if they're aware of the tradeoffs. For example, an investor may concentrate on Treasury bonds to eliminate credit risk (at the cost of lower returns over the long term compared with investing in corporate bonds). Or, an investor may emphasize short-term bonds to minimize interest rate sensitivity (and give up the higher income that longer-term bonds provide).
- Credit quality refers to the likelihood that a bond's principal will be repaid by the issuer. The higher a bond's credit quality, the lower the risk of nonpayment or default—and, generally, the lower the yield.
- Bond prices change in the opposite direction of interest rate changes. We refer to the magnitude of the price change as interest rate sensitivity. The longer a bond's maturity, the greater its price will fluctuate in response to changes in interest rates.
Diversification does not protect against a loss in a declining market or ensure a profit.