[Investing] High-quality bonds can diversify risks during adverse market conditions

Some people think bonds are “boring” because you rarely hear news about them. Bonds are generally less volatile than stocks, as is their long-term return potential. However, bonds can provide you with regular and stable income while balancing the overall risk of your investment portfolio, especially during downturns when stocks tend to perform more volatilely.

What are bonds?

Simply put, a bond is an agreement issued by a government or business to raise funds (loans) from investors. The issuer promises to repay interest and principal on a set date (the “maturity date”). Traditional bonds have fixed and recurring interest payments (coupons), which is why bonds are called fixed-income investments. However, variable or floating rate notes based on a base rate are also quite popular.

How does it work?

Bond prices are inversely related to interest rates. When interest rates rise, bond prices fall, and vice versa. For a $100 bond with a fixed coupon rate of 5% and a term of 5 years, the investor will receive interest income of $5 per year for four years, and receive principal of $5 and $100 in the fifth year.

Bonds carry credit risk, and the issuer’s ability to pay is measured by industry credit ratings. A bond’s credit rating indicates its credit quality, and the rating criteria are based on the issuer’s financial ability to pay interest regularly and repay the loan in full on the maturity date. Credit rating agencies, such as Moody’s and Standard & Poor’s, assist investors in assessing a bond’s creditworthiness.

Investment grade vs. non-investment grade bonds

Investment-grade bonds generally have higher ratings (i.e., BBB- or above by S&P and Fitch Ratings), while high-yield or junk bonds classified as non-investment-grade bonds generally have lower ratings (below BBB-). and involve a higher risk of default. Such bonds tend to pay higher coupons to compensate investors for the risk they bear.

When the economic outlook deteriorates, investment-grade bonds are generally preferred because their higher quality helps enhance portfolio resilience. Conversely, when market sentiment is hot, high-yield bonds tend to be more popular.

Bonds are often a good portfolio diversification tool and can help investors navigate market fluctuations. Feel free to contact us to find out which bond type is right for you.