As we have said before, bond investing is not difficult to understand, but it is, like every other investment, something to be thought about and planned before committing your funds. All the risk/reward trade-offs in bond investing are understood by the professionals who work with bond investing every day, but are sometimes less obvious to the retail bond investor.

If you want to be making a low-risk investment in bonds, then you will need to get across the basics of how the bond investing markets work, and how to tell an investment-grade bond from a junk bond – called “high-yield bonds” by the politically correct.

A bond is essentially a loan to an organisation – you give a pile of your hard-earned capital to the bond issuer, and they agree to pay you a fixed amount (called the coupon rate) each month until the bond matures, at which time they will return your investment.

Clearly, if the bond is being issued by the US government, you can sleep secure in the knowledge that the money will be returned in full when the bond matures in ten years’ time. On the other hand, if the bond was being issued by Slippery Joe’s Used Cars And Auto Parts Barn, located in Pipsqueak, Utah, you may not be quite so certain …

Bonds are rated based the likelihood that you will get your money back when the bond matures. The highest rating, AAA+, is applied to extremely secure investments like government bonds. Other large, reasonably stable organisations would be rated at various levels of A, down to A-. Organisations get quite worked up when ratings agencies downgrade their rating!

Below a rating of BBB, bonds are called “junk bonds”, because the perceived risk of losing your capital is too high. It’s all very well getting a 15% return for a few years, but if you lose your investment in the end it was hardly worth it, was it?

When it comes to the risk/reward trade-offs in bond investing, you need to bear in mind that reward is always commensurate with risk. If a bond has a high rate of return, it is because nobody will buy it at any lower rate, due to the perceived risk. The lowest risk strategy for bond investment is bond investing.

Of course, there are ways to trade and speculate in bonds, and achieve higher returns with equivalently higher risk. However, if you are at the point in your investing career where you are looking for secure fixed income, you should be investing in bonds rather than trying to make capital gains by trading in bonds.

When you are looking for secure, fixed income returns, bonds are a good investment option.

It is vital that you completely understand the the risks and rewards of bond investing before you start your bond portfolio, or you could find yourself exposed to rather more investment risk than you had intended! Consult your investment advisor to determine which bond investing strategies are appropriate for your situation.

Next Post: Are You Guilty Of Credit Abuse?