Day Trading & Forex Forum

The majority of articles that the private investor will read in the financial press, and on online media sources such as Trade2Win, focus on equities and equity linked products such as unit trust, ETFs and other types of packaged products. Yet, a quick glance in the back of the Financial Times will reveal that there is a vast universe of government and private-sector bonds to be traded, with new issues coming daily, often valued at a billion of dollars or more.

But who cares? Equities are exciting. There is always a story…….  takeovers, acquisitions, disposals, results and profit warnings all keep the rumour mills spinning nicely while the high volatility of equities holds out the promise of great rewards. Double-digit gains and more are sometimes achieved over short periods of time, and a good bull run can see the holder of such instruments make a return on his investment that can be measured as a multiple of the original investment. So who would want to buy a boring old bond? The price does not move much, and who cares about the yield?

Perhaps we should think again. Over a period of time, an asset providing a consistent yield will outperform a volatile but low yielding one. Let us look at the numbers……. suppose we take an asset and hold it for a period of time, reinvesting the income as we go. What will we achieve?

Not bad, I think that you will agree, particularly if the gains are left to compound for longer periods!

Here’s a summary of why I think every portfolio should contain some bonds:

Predictability: Bonds differ from equities in one other very important aspect. In order to realise your profit (or loss), you must sell the instrument back to the market – at whatever price the market happens to be quoting. But when you buy a bond, the redemption date and amount are fixed in advance, so reducing your reliance on fickle market sentiment or changing liquidity.

This is a vital advantage for people who have excess cash to invest now but who know that, at a certain point in the future, they will have to meet liabilities such as school fees or retirement. What’s more, you won’t run the risk that the stock market will enter one of its unpredictable bear phases at the very time you need to convert your investments back into cash.

Income: With an ageing population in most developed countries, income becomes an increasingly valuable aspect of any portfolio. Income available from bonds is generally higher than that available from equities. Future income payments are a known quantity, unlike dividends from equities, which may be reduced or withheld entirely in times of low profitability. This makes bonds ideal if you wish to create an income portfolio. With bonds paying annually, semi-annually or sometimes quarterly, a carefully chosen bond portfolio with six or more holdings can produce a reliable monthly income.

NB: Most bonds pay their coupons gross, without withholding tax. You can take advantage of this by holding qualifying bonds within an ISA or a SIP, where they will provide a tax-free income. This is a considerable advantage over the dividend on equities, which suffer from the cruel attention of our Scottish chancellor!

Diversification: A well-managed portfolio should contain a variety of different assets classes. Equities, government bonds, index-linked bonds, corporate bonds, property and alternative assets all have their role to play. This simple approach is one of the most effective strategies for reducing risk in a portfolio, and investors should note that in certain economic scenarios, such as a recession, bond prices will generally move in the opposite direction to equities (for instance over the 200-2003 bear market).

Benefit from falling interest rates: When you buy a bond, interest rates are locked in for a defined period. Because of this, falling interest rates will cause the market value of the bond to rise. If you buy bonds as interest rates fall, you’ll receive the double benefit of a secure income and capital appreciation of your asset. If you hold bonds that mature at different dates, you can also protect yourself against rising interest rates by using the capital that returns to you on redemption to buy new bonds that offer a more competitive yield.

Trading: Any financial instrument offers the potential to speculate on future price movements – and bonds are no exception. Traders often use the highly liquid government bond markets to speculate on future interest rates, while the prices of corporate bonds can move sharply on changes in the perceived credit quality of the issuer.