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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35361  
Subject: Re: why bond Date: 4/20/2009 11:16 PM
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A bond is a contract to make specified interest payments on specified dates and then refund the full face value (ie par value) of the bond on a specified date, ie the maturity date. That makes the bond a near certainty to give a specified rate of return--unless the company becomes financially unable to pay.

So owning bonds themselves is a conservative investment with an almost certain return when held to maturity. To guard against risk of default you buy better quality, investment grade bonds, and then watch them to see that the company's financial condition does not deteriorate.

The bond pays a fixed interest payment, called its coupon. But if you went to sell the bond before maturity and your bonds interest rate is not competitive with market rates at the time, who would buy it? So bond is discounted (ie sold at less than face value) to compensate when interest rates rise and priced at a premium (ie priced above face value) when interest rates fall. But this only matters if you sell the bond. However, your account statements will show your paper losses or gains as interest rates change.

Most individual investors are ill prepared to trade bonds. (The secondary market even for listed bonds tends to be expensive--especially for small investors.) So most small investors are best off to hold to maturity and ignore those paper profits and losses. As long as the bond pays its interest, leave it alone. But if the company might be headed for bankruptcy, you might consider selling. Or you might sell to settle an estate. Otherwise, sell only in an emergency.

Interest rates are likely to stay low as long as the economy is in recession. Rates will probably rise when the economy recovers. And people worry about the large deficits and govt borrowing pushing up rates (and inflation from that reducing buying power of your money when the bond matures).

Bonds are probably a good place to park your funds while the stock market is uncertain and in turmoil, but most will want to return to higher equity allocations once the market stabilizes. That is also when interest rates are likely to rise. So now is an attractive window for conservative investors to invest in bonds.

Note that trust preferred issues now are traded on the NYSE and can be bought and sold at discount broker commissions. These are essentially bonds traded as preferred stocks and offer the potential to trade bonds for individuals--quite different from traditional bonds.

As to bond funds, they are a bit different because interest rates have a greater effect on them. I'm not familiar with the ones you mention, but they seem reasonable. The short term bond fund probably pays a lower yield and is intended for those who think interest rates will rise while they own shares in the fund. The others will react more to fluctuations in interest rates but are probably OK.
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