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Why bonds?
In Lesson 7
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Money 101 Lessons
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Think "bonds," and you probably think "safe," "reliable," and . . . "boring." But that is only half the story.
Bonds can provide a worry-free stream of income. But this class of securities, which crushed stocks during the three-year bear market of 2000 through 2002, also includes a wide array of instruments with varying degrees of risk and reward.
Used improperly, bonds can really mess up your financial life. Handled with care, however, bonds are among the most valuable tools in your investment kit. Here are some of the benefits they can provide:
- Diversification. Large company stocks have posted compound annual returns of around 10.4 percent since 1926, versus 5.9 percent for long-term U.S. government bonds, according to Ibbotson Associates. Yet while stocks have returned more than bonds, they are also more volatile. Combining stocks with bonds will net you a more stable portfolio. As seen during the bear market, bonds' positive returns offset the double-digit losses from stocks.
- Income. Because bonds pay interest regularly, they are a good choice for investors -- such as retirees -- who desire a steady stream of income.
- Security. Next to cash, U.S. Treasurys are the safest, most liquid investments on the planet. Short-term bonds are a good place to park an emergency fund or money you'll need relatively soon - say to buy a house or send a child to college.
- Tax savings. Certain bonds provide tax-free income. Although these bonds usually pay lower yields than comparable taxable bonds, investors in high tax brackets (generally, 28 percent and above) can often earn higher after-tax returns from tax-free bonds.
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