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What Is Bond Diversification?

C. Mitchell
C. Mitchell

Bond diversification is an investment strategy in which money is funneled in multiple bonds, usually with varying maturity dates and interest rates. Investors often chose to purchase a range of bond interests as a way of safeguarding assets against defaults and market declines. Bonds are usually regarded as more stable than stocks but, like all securities, they are prone to failure or dramatic drops. Diversifying a portfolio is the best way for bond investors to protect their assets, and gives the best chance of a positive return.

The bond market is considered generally predictable in most places. Bonds are essentially loans to government entities or major industries. They are often more dependable than stocks and usually follow a sort of inverse trajectory to the stock market: when equity interests fall, bond interests often rise, and vice versa. Many investors who want more robust asset protection invest in both stocks and bonds simultaneously. Investing in bonds can be as simple as buying up one interest, but most of the time, various holdings are purchased simultaneously, a practice known as bond diversification.

Woman with hand on her hip
Woman with hand on her hip

There are many different kinds of bonds, and many different bond terms as well. Bonds are often offered by municipalities, state and provincial governments, and national treasuries. Major industries, such as petroleum and precious metals mining, may also sell aggregated bond interests. These can be offered as short-term bonds, usually six months to a year, or long-term bonds, often 20 years or more. Bond diversification happens when investors put money in a range of different kinds of bonds, with different return structures.

Bonds work as interest-based loans in most cases. Investors pay a principle to purchase a bond, then see a slow but steady return on an amortized basis. This is often monthly, but can also be annually or biannually, depending on the terms of the exchange. When the bond reaches maturity — that is, when its time is up — the investor is refunded the entire amount of the principle. Bonds can be a good way for investors to receive regular interest payments over time with the promise of full refund later on down the line.

The bond market is not foolproof, which is where diversification becomes important to many investors. Lenders depend on the continued solvency of lendees. A municipality that goes bankrupt may be unable to repay all purchased bonds, for instance. Bond interest rates can also plummet, costing investors anticipated gains.

Most financial advisers recommend fund diversification amongst bonds so as to protect against possible devaluations or market failures. This usually involves choosing some bonds that are so-called “low risk,” and others that are considered “high risk.” The precise allocation usually depends on the lender’s financial stability and how badly they need to see dependable returns. In general, conservative bonds are more stable, but return less, whereas riskier investments usually return much more in the short term, but are more likely to fold or fail. Financial diversification helps investors strike a balance between both extremes.

Asset diversification in the bond market is particularly useful for people who do not have a lot to gamble, particularly retirees. Retirement diversification often depends on investments that are perceived to be more stable. This sort of decision-making often leads to lower short-term returns, but also insulates against the possibility of major long-term losses.

Most of the time, bond diversification is handled by qualified investment professionals and financial advisers. These professionals make their living by watching the market and understanding the risks involved with all sorts of market investments. They will often select the bonds that will make up a bond diversification portfolio for given clients. Depending on an investor’s sophistication, he or she may also elect to choose a range of different funding options independently.

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