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Investing for a Lifetime: Managing Wealth for the "New Normal" by Richard C. Marston

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CHAPTER 10 Investing in Bonds: The Basics

Bonds are the bedrock of any portfolio. As with buildings built on bedrock, portfolios with bonds have a solid base. We don’t expect to earn high returns with bond investments. After all, bonds provide fixed coupons with little upside, at least in normal times. But we expect our bond investments to be safe.

Unfortunately, bonds have weaknesses. These solid rocks crumble when inflation occurs. In the inflation-ridden decade of the 1970 s, bonds lost ground to inflation. So bond investors ended up poorer than at the beginning of the decade. This is something to keep in mind when we examine the history of bond returns. We should also be mindful of credit risk. If a bond provides a much higher yield than offered on U.S. Treasury bonds, the bond probably has credit risk to worry about.

This chapter will study U.S. Treasury bonds, bonds that are free of default risk (despite the views of one rating agency).1 That will allow us to examine the impact of inflation on bond yields. We will also study how bond yields vary by maturity. In this chapter we will also discuss various strategies for investing in any type of bonds (not just Treasuries). Strategies will include “buy and hold,” “laddering” the bond portfolio, and investing in bonds via mutual funds. Then in the next chapter we will study non-Treasury bonds like those issued by corporations. Credit risk is obviously an issue with some of those bonds. Finally, we will examine municipal bonds. ...

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