A Primer on Bond Investing

Generally speaking, there are three things that investors need to consider when investing in bonds right now. Those key considerations will help to determine whether or not an investor is going to be happy or miserable with the bond purchase and whether or not potential losses are mitigated. This has become increasingly important at this point in the economic and market cycle as interest have reached about as low as they can and with an economic recovery will come higher rates which consequently means lower bond prices. Here are three key considerations to keep in mind when evaluating bonds for your portfolio.

1. Long or Short. If you have an existing bond portfolio, consider what today's purchase(s) will mean for the overall maturity of your portfolio. If your currently hold a lot of bonds with long maturity dates, consider working toward bringing that weighted maturity value lower. The brightest and best bond managers are looking at weighted maturities of under 7 years for their portfolios.

2. Rating. Depending on how you managed your bond portfolio in the past, your average bond rating might be too high or too low. In periods of rising interest rates, the higher quality bonds will not be as volatile, but at the same time the returns and income from those higher quality bonds will not be as worthwhile either. Keeping your portfolio's average bond rating in the AA to A area is most prudent and for those with a little more risk tolerance, the A to BB range is probably well advised. Anything below that could result in higher volatility and losses.

3. Average Price. Although it may be difficult to find bonds with short maturities and high credit ratings at par or just above par, using average price to incur some losses to offset years of unrealized gains could be a smart investment strategy so as to eliminate large gains taxes. Even if used as a preventative measure, increasing your cost base could help to prevent big tax burdens. (Ideally, lowering your cost base could have excellent long-term implications, but is generally difficult to do in periods when rates are poised to increase).

These three basic considerations are essential when deliberating establishing a position in bonds. Although this is nowhere close to being an exhaustive list of things you need to look at, making sure you can achieve your overall portfolio goals by keeping these items in mind will definitely provide benefits to your bond portfolio.

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Chris has more than 17 years of financial services experience. He is a regular contributor at the Mutual Fund Site where he often writes about various Equity Funds, either reviewing them or discussing the asset class as a whole.