Tips for Choosing the Best Bonds

Bonds are a popular investment choice because they have the potential to earn investors a significant amount of money. Governments, municipalities or companies make bonds available to the public when they need money to fund specific projects or fulfill short- or long-term goals. You, as the investor, are basically loaning money to the entity when you buy the bonds. The entity is required to pay you periodic interest based on the number of bonds you've purchased. The interest rate on bonds is called coupons and it's typically paid semi-annually. At the end of the life of the security, the entity is required to pay investors the full principal amount.

The question many people have is whether they should add bonds to their investment portfolios and when they should do so.

Every person and their life circumstances are different, so there's no easy answer to that question. Experts say it's important to diversify a bond portfolio across various sectors to make the most out of your investments. But the types of bonds you purchase will depend on your stage in life. From an investment perspective, there are three stages of life: the accumulation stage, the consolidation stage and the gifting/spending stage.

The Accumulation Stage

This is usually during a person's early stages of their careers. Investors tend to be younger in this stage and have a longer time before they need to cash in on their bonds. They also tend to have a higher tolerance for risk. High-yield bonds and international bonds could provide the most return for your investment.

High yield bonds are sometimes called junk bonds which were invented by Michael Milken in the 1980s, according to some financial historians. The man ended up going to jail for mishandling the fundraising process. High-yield bonds are favored by companies with poorer credit who have difficulty getting financing the traditional way. The benefit for investors is that they could provide higher returns if the investor has the time to wait.

International bonds tend to be more volatile especially if they're coming from countries with less developed markets.

The Consolidation Stage

Investors in this stage are usually in the mid- to late-stage of their career. The time horizon is shorter but not so short that the individual won't be able to wait out riskier investments until the return is higher. Investors also have more money to invest.

At this stage, municipal bonds are a popular choice. Yields are lower, but they're generally exempt from taxes. They also generally provide a steady stream of income.

The Gifting/Spending Stage

Investors tend to be older and close to retirement. Bond purchasing isn't often started at this point in an investor's life. If it is, low risk ones tend to be favored since the investor often can't afford to take the losses. He or she may also want to make sure any bonds purchased during the previous stages will outlive him or her, especially if there's a beneficiary to whom the money will go after the investor is deceased.