Why Bonds Should Feature in Your Investment Portfolio

While "charity begins at home", investing is a global e

No doubt, stocks have the appeal. After all, why shouldn't a 100% price gain in one month command a lot of attention. Or indeed, the reverse of a colossal weight-shedding of similar magnitude. All these are possible in the stock market. Besides, companies are coming to the market with new issues all the time, and, given the massive promotion that attends those issues, you can't deny the stock market its glamour. That cannot be said of the bond market, especially in Nigeria. For one, corporate bonds are a thing of history as companies have seemingly shunned the bond market. That contrasts sharply with the US market, where the debt securities market is about twice the size of the equities market ($38.8 billion : $18.2 billion for Q4, 2005; source: “Flow of Funds” data of March 2006, by the Board of Governors of the Federal Reserve System). Something they know that we don't or the reverse? With only the FGN series bonds being offered and traded here, it's so much of a quiet business, largely unknown of by the ordinary person out there, including even stock investors. Talk of a drab bond market: no variety whether in issuers, features or other dynamics of bond trading. Okay, does all that rule out bonds as an investment option for you? No, no no!

Bonds Count, Colorless Market or Not
Bonds are a debt instrument (read Bonds: What They Are...), providing earnings in their own right and in a number of many ways different from stocks (see How Bonds Differ From Stocks). That makes them unique for a possible role in your portfolio of investments. Ultimately, they provide an option for a more rounded investment strategy, meaning that you need to give attention: one, to understand bonds, and, two, to evaluate what role they could play in your investment process. To help you in that process, we examine here the key roles bonds can play to advance your financial stability and investment success:

• Risk Diversification, a Core Investment Objective
  Given our pervasive pre-disposition to quick gains, the idea of investment safety appears to sound remote to many investors who would easily plug all their resources into the stock market in the calculation that it promises higher returns. A massive market fall will easily bury most such investors. A risk-diversified portfolio aims to balance returns and risk, seeking to place the investor at an optimal point. The idea is to generate wealth while taking steps to protect it. Bonds are repayable at maturity and when they are bonds of the Federal Government, their default risk pales into insignificance. If you want to earn returns on your investment and worry about safety too, bonds will matter to you. That is most-importantly as a class of assets in a portfolio that can still accommodate the more aggressive assets like stocks, ensuring some balance of safety and earnings potential.
• Steady Income Stream
  Sure, you can sell some stocks for running cash, though you won't enjoy this if the timing is bad, like when prices are low. If you expect income from stocks by way of dividend, you must wait till year-end and pray that a dividend is recommended and declared. Bonds in your portfolio will provide an income stream: interest on bonds is paid at specified intervals and at a fixed interest rate, meaning that a steady income stream is available to you. Planning couldn't be easier! If you are in retirement for instance, this probably allows you retain your principal investment while supporting yourself with the periodic interest payments.
• Price Moderation
  Bonds have a par value, repayable at maturity. If you are ready to hold your investment to maturity, you get full redemption. You may however choose to sell during the life of the bond, just as with trading in stocks. Because bonds are traded, the market (resale) price fluctuates, also like stocks. However, bond prices move in narrower bands and besides, you can always hold and be sure of your principal at maturity. The effect is that the investor suffers less of the trauma of tracking and watching stock price summersaults. If your heart palpitates with each movement of share prices, bonds possibly deserve your look-in.
• Balance of Returns and Safety
  Bank Savings could save you the risk of stock market loss since your money is reasonably secured, if with a strong bank. But bank interest rates are usually too low to absorb inflation and leave a positive real return. The FGN bonds leave you better off: they provide a better yield, even while assuring a much lower risk of default. So, when safety of principal is a high priority, meaning that the risks of the stock market are not welcome, bonds offer a good alternative. Retired and can't afford to toy with your nest-egg? Consider investing in bonds, especially if the interest income will be enough to meet your routine needs. Saving for a particular purpose that can't be risked investing the money in stocks? FGN bonds are a relatively much more secure alternative.
• Tax Advantage
  Worried that tax with eat into your investment income? That 10% withholding tax on dividend and bank deposit interest is a pain, isn't it?. Take the bond alternative, investing in the FGN bonds - they are tax-free. Depending on your level of investment, that tax-saving could work out to a sizeable figure.
• Investment Flexibility
  Like stocks, bonds are flexible to invest in: you can buy in affordable tranches. Unlike buying into the real estate market, for instance, you can invest in the FGN bonds with a minimum of N10,000. Bonds are denominated in par values of N1,000 per unit, that means you need to pick a minimum of ten units in one transaction, but, certainly, that isn't back-breaking by any means.
• Tradable Security
  You can resale your bonds in the secondary market, just as you would sell your stock and also with the possibility of a transaction profit, since the market price can appreciate. Bonds are traded at the market price which could be at par, below par or above. In effect, you can sell at a premium. Besides, the marketability allows the flexibility to get in and out of the investment, depending on your needs. All you need do to sell or buy is to approach any of the Debt Management Office approved Primary Dealers/Market Makers, mainly the discount houses and universal banks.

Now Love Bonds?
Well, whether you do or not, bonds are an investment asset that can fit into your investment portfolio. Financial experts expect that a balanced portfolio, designed to withstand shocks, will command a spread of assets, including some level of bond-holding. This is not to compel you to invest in bonds. The message, all the same, should be clear: bonds are not as drab as it may seem. They could play a vital role in your personal financial management equation. Next time you are engaged in asset allocation (see this article), think again whether you don't need some FGN bonds in there. If the value of your stocks fizzle out overnight, for instance, all you may own could just be the bonds, guaranteed by the Federal Government of Nigeria.

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