Buying bonds or mutual bond funds has typically lower risks than investing in stocks. The length of time and risk tolerance help guide the strategy we can employ to achieve the financial goals.
The investor who is close to retirement or is already retired may seek for steady income after retirement and capital preservation. The timeline can be 20, 30, or more years on the horizon. He or she may have a moderate risk profile and invest in high credit quality, investment-grade bonds.
In contrast, a young investor with a higher risk appetite may be more appropriate to buy short-term high to mid grade quality bonds because he or she can take advantages of two things by doing so:
- Time to maturity is short so he or she can react to the trends of the interest rates.
- Typically, the lower grade of the bonds, the higher the interest rates are offered.
- Diversification: Generally, it is not a good idea to have all your investments in a single risk or asset class.
If your objective is to preserve your principal investment and earn interest, consider a “buy and hold” strategy.
A “buy and hold” strategy is to buy bonds and hold them to maturity. In this situation, the investor receives periodic coupon payments over the life of the bond and full repayment of principal at maturity. The price fluctuation of the bond over time does not matter because, in the end, the bond matures and the investor gets the face value of the bond back. The risks here? The quality of the bond and the purchase price.
If the bond is purchased at a premium, you will receive at maturity less than the amount you pay for the bond. If the bond is purchased at a discount, you will get more than you originally pay for at maturity.
Buy and hold strategies work best with high-quality bonds because the investor has a lower risk when or if the issuer defaults.