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Chapter 7. Bonds > Why Invest in Bonds?
7.1. Why Invest in Bonds?
As you saw above, bonds can play several roles in your investment portfolio. But don't expect a single bond to do everything all the time. Here's a quick overview of what bonds can do for you (the rest of the chapter explains how they do it in detail):
Produce income. Because most bonds pay regularly scheduled interest, many people invest in them and then live on those interest payments. But bond returns typically aren't high enough to grow your nest egg to achieve long-term goals, so you probably can't afford to invest all your money in bonds. As you'll learn in Chapter 10, you may end up using bond interest, mutual fund distributions (Section 4.2.1), and, in some cases, small withdrawals of your portfolio's principal to foot the bill for retirement expenses.
Produce capital gains. Bond prices go up when interest rates go down (get the full scoop on Section 7.2.4). If you buy bonds when interest rates are high and sell them when rates fall, you actually get more money for the bonds than you paid for them. That happens when you buy bonds that pay a high interest rate (to stay competitive with market interest rates). If market interest rates fall, bonds that pay higher-than-market rates are worth more. Keep in mind, however, that investing in bonds for capital gains is a lot riskier than holding bonds until they mature, so most individual bond investors simply hold bonds to maturity. Suppose you buy bonds and interest rates go higher instead of lower, and you get into a situation where you have to sell them; your bonds will be worth less than what you paid for them and you'll lose money.
Reduce your portfolio risk. If you hold a bond until it matures, you earn income based on the original interest rate the bond issuer quoted (called the coupon rate). With top-quality products like U.S. Treasury bonds or AAA-rated corporate bonds, holding them to maturity is almost a sure bet that you'll make money. Bond prices may go down, but they usually don't drop percentage-wise as much as stock prices.
