Risk is a constant in investment. After all, no one can predict the future with absolute certainty, which means that no one can say that something will turn out exactly as expected. Of course, some things are much riskier than others. For example, the chances that a small business will default on its debt obligations can be quite high. On the contrary, the chances of the US federal government defaulting on its debt obligations are quite low, so much so that if it happens, it is very likely that everyone has something much more serious to worry about than the state of their portfolio. investment. On this basis, it should come as no surprise to learn that there is a wide range of methods used to manage investment risk, diversification being an excellent example.
For those unfamiliar, diversification means putting a mix of investments into an investment portfolio in order to manage risk. Basically, the intention is to make sure that the poor performance of some investments is offset by the good performance of other investments, which is why it is so important that the investments are not perfectly correlated with each other. This is one of the reasons why countercyclical investments are so useful.
Should You Diversify Your Bonds?
By investment standards, bonds are quite predictable. As a result, diversification is not as useful for bonds as it is for stocks, which are a much more unpredictable type of investment. In addition to this, although diversification can be used to reduce the risk of bonds, there are other risk management methods that can be used to achieve the same objectives. For example, buying a wider range of bonds can reduce the potential harm from a bond issuer that defaults on its debt obligations. However, stakeholders can do the same by predicting whether or not a particular bond issuer will be able to deliver on its promises within the life of the bond, which is much easier than predicting whether the share price will rise. or it will go down at a certain point. point in time.
That said, it would be a shame not to diversify the bonds. To some extent, this is because bonds are one of the best ways for interested individuals to diversify their investment portfolios. After all, bonds are not highly correlated with other types of investments, which means that they are not very susceptible to the same problems. In fact, it’s worth mentioning that bonds can even be negatively correlated with stocks, which explains why the two pair up so frequently even in the simplest investment portfolios.
In any case, there is an even better reason to bundle bonds with other types of investments, which is that bonds are not as rewarding as many other options out there. They are predictable. Unfortunately, that same predictability is considered very attractive to interested parties, which means that bonds do not need to offer as high returns as many other types of investments. As such, people cannot expect great rewards by investing in bonds and nothing but bonds. Yes, investing in other types of investments will mean more risk, but the mere presence of bonds will reduce that risk to some extent. Also, it’s worth mentioning that long-term bonds have become less valuable in recent times, thus eliminating a potential option for people who want to make a profit through investing in bonds.
How should you diversify your bonds?
Investing in a broader range of bonds would be one way to diversify bonds. However, investing in other types of investments would be another way to diversify bonds. The two are not mutually exclusive, so it is perfectly possible to participate in both at the same time.
In any case, the choice of investments for diversification purposes still depends on what the interested parties have in mind. Because of this, they need to establish certain criteria for the types of bonds that interest them based on their investment objectives. This may refer to the expected return on the bond. However, this can refer to several other criteria, such as its duration, its issuer, and its potential risks. Note that the introduction of new types of bonds may introduce new types of risks even if they serve to mitigate existing risks in the investment portfolio. For example, some people may be curious about foreign bonds. Such investments can be very useful, but there is an important point in the sense that bonds …