Financial health shares many characteristics with physical and dental health. It is important to constantly monitor current conditions and keep reviewing and revising our strategies to stay healthy, especially as we age. This has been a real challenge lately in the financial world, so I thought some portfolio information might be helpful.
Why invest in bonds?
Understanding bonds is important to help maintain stability and diversification in a portfolio. Are you bewildered by bonds? If so, you're not alone. In fact, according to a November 18, 2001, New York Times article, 30 percent of investors indicated that they avoided investing in bonds simply because they did not understand them. Not fully understanding the importance of bonds could potentially prove detrimental to you if that lack of understanding prevents you from including bonds within your portfolio. Perhaps the best place to start is with the basics.
A bond is similar to a loan. It is a contractual obligation between the lender (investors like you) and the borrower (the issuer). A bond pays a fixed rate of interest (called the coupon) to the investor, typically two times per year. A bond has a "face value" or "par value," typically of $1,000. Furthermore, and unlike stocks, each has a pre-determined endpoint, called the maturity. At maturity, the borrower must pay in full the original amount of the loan and any remaining interest. As long as a company doesn't go into bankruptcy, you will receive your original investment, in addition to any interest income over the life of the bond.
For example, a $1,000 par value bond with a 5 percent coupon and a 10-year maturity will pay the investor $50 per year ($25 every six months) for the next 10 years, and then repay the original $1,000 at the end of 10 years.
The answer is simple — diversification. You should typically maintain a diversified investment portfolio consisting of bonds, stocks, and cash. The percentages in each category take into consideration your individual circumstances and objectives. Bonds generally are less volatile than stocks and often are referred to as "fixed income" investments. While the income from the average stock has declined dramatically over the past several years, bonds often can provide investors with a steady stream of income for further investing or to meet expenditure needs.
Bonds come in many flavors. For investors desiring capital preservation, a portfolio of high-quality, short-maturity bonds can fill the bill while providing a stream of income. However, if you seek a higher level of income, then a diversified bond portfolio can provide that by varying quality, maturity, industry, and payment type. By adding bonds to your portfolio, based on your risk profile and income needs, you have the potential to help enhance overall returns and reduce risk.
Adding value to your portfolio mix may help moderate the performance uncertainty that is often associated with growth investing.
Everyone understands the value of a good deal. If you search for high quality at a reasonable price, value investing may have a place in your investment portfolio. As some overvalued sectors of the current stock market have recently deflated, value investing has come back in favor among many investors.
When you consider the allocation of your investment portfolio, it is often helpful to diversify beyond a mix of asset classes, such as stocks, bonds, or money market accounts; you may also want to diversify based on style.
The two primary styles of stock investing include growth and value. Determining which is appropriate for your investment portfolio can be key to achieving your long-term financial goals.
In the current environment, when a slowing U.S. economy threatens to negatively impact the stock market, investing in value may help cushion your portfolio from significant declines.
With a value-investing strategy, investors purchase shares considered under-valued in the current market, yet with high potential for achieving continued revenues and profits. Typically, value stocks are those of well-established companies that already have survived a risky start-up phase. They often have well-embedded earnings and may be more inclined to pay a dividend to shareholders than reinvesting for growth.
In addition, value stocks often are steady performers that may be poised for a bounce when the market begins its upturn.
Most portfolios benefit from some application of value investing. If portfolio growth is one of your top investment objectives, growth stocks should still comprise a large percentage of your holdings. However, adding value to the mix may help moderate the performance uncertainty that may be associated with growth investing.
Given today's market, it may be a good time to re-evaluate your investment strategy to include what appear to be currently undervalued companies in your equity holdings.Kathleen Adams, RDH, BS, is a financial adviser with Waddell and Reed (www.waddell.com). She is currently trying to initiate money-management workshops for hygiene students and specializes in working with dental professionals. She can be reached at (800) 210-1357.