Fixed Income May 5, 2016

    It's easy to overlook bonds when the stock market is up and you're 30 to 40 years away from retirement. After all, stocks tend to generate higher returns in the long run. But does that mean you should forget about bonds altogether? Not really. The diversification, income and capital preservation benefits that you can get from bonds may be critical during down cycles and over the long haul.

    Here are a few good reasons to consider including bonds in your portfolio, no matter your age:

    Bonds can help diversify your portfolio. Fixed income securities, particularly Treasury bonds, typically have low or negative correlations with stocks, meaning they often move in opposite directions (although correlation can be higher for other types of bonds, such as investment-grade or high-yield corporate bonds). That can help cushion the impact of a stock market decline. You can invest either in individual bonds or in a bond fund (that is, a mutual fund or exchange-traded fund that holds bonds of varying maturities). For more on the difference between bonds and bond funds, as well as details on how bond exchange-traded funds (ETFs) work, read this article.

    Bonds can offer steady income. Bond returns come from two sources: interest payments and potential price appreciation. The interest that bonds typically generate can help counterbalance the stock market's ups and downs. Over time, the regular income earned on bonds can provide a useful cushion for riskier and more volatile investments, like stocks.

    Bonds can help you save for short-term goals. High quality, short-term bonds can be used to save for a purchase you expect to make within the next few years, like a car, wedding or house. Short-term Treasuries and short-term investment-grade corporate bonds may be good options for investors looking for higher returns than a savings account, but with less risk than the stock market, for money they need back soon.

    However, bonds have potential risks. Although generally considered to be less volatile than stocks, bonds have some unique risks. For one, bond prices tend to move inversely to interest rates. This means that when interest rates rise, bond prices usually decline, all else being equal. If you intend to hold a bond until its maturity date, price volatility may not bother you; however, if you decide to sell your bond, or your bond fund shares, during the price drop, you could lose money. Bonds are also subject to credit risk—the possibility that the issuer will fail to make interest payments or return the principal amount at maturity—as well as the risk that inflation will erode the purchasing power of interest payments and principal.

    The bottom line

    Bonds can play an important role in your portfolio in any market environment. They can help diversify your portfolio, reduce your risk and can help you save for near-term goals. True, bonds have potential risks, including credit and interest rate risk. It's also worth keeping in mind that interest rates are currently low by historical standards; if they rise from here, it could erode the value of certain bond prices. However, just as we believe you shouldn’t try to time the market in stocks, the same is true for bonds.

    Did You Know?

    Schwab Intelligent Portfolios™ includes several types of fixed income ETFs, which can include U.S. Treasuries, municipal bonds, corporate bonds, high yield bonds, and international and emerging markets bonds.

    Investing involves risks including possible loss of principal.

    Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

    Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.


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