When you hear people talk about “living off the interest from their investments,” chanceCredit: Image: worradmu / FreeDigitalPhotos.nets are that their portfolios include bonds. This is because bonds are “fixed-income” securities - they provide a steady stream of revenue to investors who agree to hold them for a predetermined period of time.
Bonds are essentially loans to organizations. The principal that the investor puts in is repaid on the maturity date of the bond. The amount due on maturity is known as the bond’s “face value.” Until maturity, fixed interest payments, also known as “coupon payments,” are made at set periods of time, usually every six months.
Why Buy Bonds?
There are two main reasons to include bonds in your investment plan. First, bonds are generally considered to be less volatile than stocks. While stocks may fluctuate unpredictably, high-quality bonds can usually be counted on to return the principal. The default rate on high-quality bonds is very low, which means the issuer will most likely be strong enough to return the face value to you upon maturity of the bond.
Secondly, bonds are an income-producing investment, meaning they provide a dependable flow of income. As opposed to stocks, where you often need to sell your shares in order to receive money (unless the stock pays a dividend), you can maintain your bond holdings and still see an inflow of cash.
Bond payment schedules can be designed to deliver income according to individual needs. This is useful for people living on fixed budgets who rely on their bonds’ interest payments to help meet their expenses. By “laddering” bonds to be due when you need money, you can create an income stream that matches up with your cash-flow needs.
Though a bond ladder may not always give you the highest possible return on the fixed-income portion of your portfolio, it is a smart strategy for people who want to try to protect themselves against swings in interest rates and desire predictability in their fiscal lives.
If you would like to learn more about bonds, visit the Profile Financial Academy.
Disclaimer: This article is for educational purposes and is not a substitute for investment advice that takes into account each individual’s special position and needs. Past performance is no guarantee of future returns.