4 Best Bond Investing Strategies for Beginners
As a beginner, it’s easy to wrongly assume that bond investments involve simply finding the highest yielding bond. But it demands more. You have to assess the different types of bonds available and find one that meets your unique needs and whose risks you can handle. Next, find the best strategies to maximize your returns.
Here are the top four bond investing strategies beginners can use.
1. Passive Bond Management Strategy
This is a buy-and-hold investment strategy that maximizes the potential return on investment. It involves holding it to maturity. You can reinvest the cash flow from the bond into the portfolio.
The passive bond management strategy involves very minimal risk and keeps transaction costs at a minimum. The only difference that can exist between the total return and the actual coupon yield is the reinvestment's made of the cash flow. The best bonds to use with this strategy are government bonds, investment-grade corporate bonds or municipal bonds.
2. Active Bond Strategy
With the active bond strategy, it seeks to maximize the total return from the bond. It involves making bets on the future and taking risks, and continuously making changes to the portfolio.
The active strategy involves things like bond swaps. Bond swaps involve liquidating one bond to purchase another, with an aim of making higher returns from anticipated changes in interest rates, yield curve shifts, credit ratings of issuers, or any other shifts in the bond market.
This strategy partly resembles the passive buy-and-hold method, but with some flexibility. You can make changes to the portfolio to mimic the targeted bond index in terms of risk and returns.
The indexing bond management strategy works well with large portfolios so that it can match the size of the index. Some transaction costs will be involved when making the occasional changes in the portfolio to resemble the index.
4. Immunization Bond Strategy
This strategy seeks to protect the bond from the fluctuations in interest rates that cause a change in bond prices. It involves changing the portfolio duration to match your investment time horizon and keeping the interest rate fixed, regardless of the bond market conditions.
The assurance of getting the desired return at the end of the investment period minimizes risks. This strategy sounds similar to the passive buy-and-hold strategy. However, with the purest forms of the immunization strategy, such as investing in a zero-coupon bond, there is nil variability in returns from reinvesting cash flows.
Finding the best bond is the easiest part of bond investment, the real task is in picking the right investing strategy based on your goals and risk tolerance.
While all these four strategies are effective, some carry more risk but also come with the possibility of making a higher return, such as the active bond strategy. The immunization and passive bond management strategies are safer but come with the opportunity cost of giving up the possibility of making more returns.
With the indexing bond management strategy, you get a little of both active and passive management styles.