Importance Of Bond in Investment Portfolio
When it comes to investment portfolio management, many investors tend to focus on equities, as they are often seen as the most exciting and potentially profitable asset class. However, it's important not to overlook the role of bonds in a well-diversified portfolio.
Bonds, also known as fixed income securities, are debt instruments issued by governments, corporations, and other organizations to raise capital. When you invest in a bond, you are essentially lending money to the issuer, who promises to pay you back the principal plus interest over a specified period.
While bonds generally offer lower potential returns than equities, they also come with less risk. In fact, bonds are often referred to as a "safer" investment, as they are less volatile and less likely to experience large swings in value. This makes them an important component of a well-diversified portfolio, as they can help mitigate risk and provide a stable source of income.
One of the main benefits of bonds is that they can help balance out the riskier components of a portfolio, such as equities. When equity markets are performing well, bonds may underperform, but they can help limit losses during market downturns. This is because bond prices tend to rise when interest rates fall, which typically happens during economic downturns. As a result, a well-diversified portfolio that includes bonds can help cushion the impact of market volatility.
Another important benefit of bonds is that they provide a reliable and predictable source of income. While equity dividends are not guaranteed and can fluctuate from year to year, bonds typically pay a fixed rate of interest, which provides a steady stream of income for investors. This can be particularly important for retirees and other investors who rely on their portfolios for income.
In addition to their risk mitigation and income-generating capabilities, bonds can also provide a valuable source of liquidity. While equities may take some time to sell in order to generate cash, bonds can generally be sold quickly and easily, providing investors with a readily accessible source of funds. Bonds typically have a more predictable income stream and a fixed maturity date, which makes them easier to value and trade. However, it's important to note that liquidity can vary depending on the specific bond or equity in question, as well as market conditions at any given time. Some bonds may be less liquid than certain equities, especially those issued by smaller companies or those with less well-known credit ratings. In addition, extreme market conditions can lead to decreased liquidity across all asset classes. Therefore, it's important to evaluate the liquidity of a specific security based on its individual characteristics and market conditions at the time of evaluation.
Of course, not all bonds are created equal, and investors need to carefully consider the risks associated with individual bonds before investing. For example, government bonds are generally considered to be less risky than corporate bonds, as governments are less likely to default on their debt obligations. Similarly, bonds with longer maturities tend to be more sensitive to changes in interest rates than bonds with shorter maturities.
Strategy to invest in fixed income assets to manage a well-diversified investment portfolio has been utilized by major investment firms, including Government-Linked Investment Corporations. Taking the Employee Provident Fund (EPF) as an example, the Malaysian government-managed retirement saving fund manages a large and diverse portfolio of assets that are allocated across multiple asset classes. The EPF's asset allocation strategy aims to achieve a balance between capital preservation and long-term growth. Guided by EPF’s Strategic Asset Allocation (SAA), EPF’s investment portfolio in 2021 shows 45% of the fund’s portfolio consists of fixed income instruments, while equities comprised 44%. Real estate and infrastructure as well as money market instruments made up 6% and 5% of EPF assets, respectively. The SAA has kept the fund resilient to financial shocks and remain stable in unprecedented situations.
In conclusion, while equities may get more attention from investors, bonds play an important role in investment portfolio management. They can help mitigate risk, provide a stable source of income, and offer valuable liquidity. By including bonds in a well-diversified portfolio, investors can create a balanced investment strategy that can weather market volatility and provide long-term growth.
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