Investors commonly purchase bonds
as a way to add diversity to their portfolios.
There are several ways investors can invest in bonds.
In this video, we'll explain two common ways
to do this, buying individual bonds,
and purchasing shares in a bond fund,
such as a mutual fund or exchange-traded fund,
also known as an ETF.
Also in this video, we'll examine the benefits and risks
of investing in an individual bond versus a bond fund.
Let's get started.
We'll begin with individual bonds.
Individual bonds are considered a less risky investment.
Two reasons are, one, a bond provides regular interest
payments, and, two, a bond returns
the original amount of the investment or principal
at maturity.
By investing in highly-rated individual bonds,
an investor can feel confident that the bonds may
deliver on these two promises.
Of course, changes in interest rates
can cause a bond's value to rise or fall.
But this only matters if you sell your bond before maturity.
In fact, if you wait until maturity and rates keep rising,
you don't have to worry.
You'll still receive your original investment
when the bond reaches maturity.
Many investors consider it to be a benefit of individual bonds.
However, purchasing individual bonds has its drawbacks.
Some people may not have the funds
to purchase a bond because bonds are commonly
sold in denominations.
A minimum denomination may be as low as $5,000 or as high
as $20,000.
This may result in an investor purchasing bonds
from only one issuer, which can lead to a poorly
diversified bond portfolio.
Diversification is as important with bonds
as it is with stocks because purchasing bonds from an issuer
means the investor must rely on the issuer's
financial strength.
Unlike individual bonds, bond funds
allow investors to easily diversify their bond
investments because the fund has ownership of several bonds.
Now that you've learned what an individual bond is
and its risks and benefits, let's move on to bond funds.
A bond fund is an investment that pools money together
from many investors to purchase a variety of bonds.
Investors buy shares of the fund and receive
dividends paid by the fund.
Investors buy shares of the fund, which entitles them
to the fund's future earnings.
We mentioned previously that bond denominations usually
require at least $5,000 to buy individual bonds.
However, buying a share in a bond fund
tends to be much cheaper.
This is also true for a bond ETF.
Additionally, a bond fund may provide
built-in diversification.
While bonds tend to fluctuate less than stocks,
they do fluctuate in value.
A bond fund also doesn't provide the assurance
of consistent interest payments and the return of principal
that individual bonds provide.
Despite the inconsistent payments,
bond funds normally do pay a dividend.
This dividend can vary, but, in some cases,
it's paid on a monthly basis.
So while the amount may be inconsistent,
regular income can generally be expected.
It's true that the fund does receive
the interest and the principal of the bonds it owns,
but that doesn't translate to the fund
shareholder in the same way as it does
when owning an individual bond.
The fund will receive the principal,
and the funds will likely be reinvested or distributed.
In review, an individual bond provides
the promise of regular interest payments
and the return of principal at maturity,
while bond funds usually require lower initial investments
and provide greater diversification.
But both investments may help reduce the overall volatility
to your portfolio and reduce risk.
So which bond investment is right for you?
Well, that depends.
As you learned, each has its own benefits and risks.
Consider your own investing goals and strategies
before making any investing decision.
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