Investing In Bonds Is Essential For Proper Asset Allocation
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If you are one of the fortunate Americans who has some disposable income, then allow me to tell you a thing or two about investing in bonds for 2013. While most of the celebrity financial advisors would have you investing in the stock market or in real estate, I would like to point out that no portfolio would be complete without proper asset allocation. In case you are not aware, this means that some of your portfolio needs to be invested in stocks, another piece would be invested in bonds, and a final piece would remain in a cash account.
A little further explanation would reveal that investing in stocks also includes investments in mutual funds or exchange traded funds. The portion left in the cash account is there for your easy access in case you want to take advantage of any market situation that strikes your interest. It can also double as your emergency fund, since as any savvy individual knows, you must have a rainy day fund set up for those inevitable emergencies.
That brings me to the part of your portfolio that you should be investing in bonds. Just as a quick refresher, investing in bonds, can be purchases in:
- Treasury Bonds
- Corporate Bonds
- Municipal Bonds (muni’s for short)
- Zero Coupon Bonds
- Miscellaneous securities that act like bonds
I personally like municipal bonds. Muni’s, as they are lovingly referred to, are securities that are issued by any state organization or any of it’s political subdivisions. The money is used for general obligations or any specific revenue generating project. The nicest feature of investing in muni bonds is that the interest that you receive from the investment is triple tax-free as long as you invest in your home state. Triple tax-free means that there is no federal tax to be paid, nor any state tax, nor any city tax.
Generally speaking, bonds pay interest two times per year, once every six months. The rate is fixed and is stated at the time you purchase the bonds. Each bond has a face value of $ 1000.00 and they mature at some point in the future which is when you get your $ 1000.00 back. So for instance, if you were to buy 10 bonds with a 5% interest rate that mature in 2023, you would give the bond issuer $ 10,000.00 and they would give you a check for $ 250.00, two times in the course of a year, six months apart. That would total $ 500.00 per year which is the 5% stated interest rate of the bond. This would continue for ten years at which point the bond issuer would give you your $ 10,000.00 back.
Ideally, you want to purchase different muni’s that pay the interest payment to you in different months. Say for example you bought bonds that pay out in January and July. Next you would try to buy bonds that paid out in February and August. Carrying this all the way through for six purchases would enable you to receive an interest payment every month of the year. This is an ideal retirement planning tool as it helps you achieve a steady monthly income.
The final point I would like to make about investing in bonds is that while no investment is totally safe, the historical default rate for municipal bonds is than 1%. This makes investing in bonds ideal for those individuals who would like to reach for more reward with little risk.
Chris Borg is a practicing pharmacist and financial adviser who writes about health care and investing. Chris’s latest website on financial freedom is at RatraceBgone, where Chris provides financial tips such as the 9 steps to financial freedom: 9 Steps To Financial Freedom
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