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If you talk about a balanced portfolio, you will have exposure to 4 main classes of assets- property, shares, cash, and bonds.
A lot of people understand property, shares, and cash instinctively; however, bonds are a different thing altogether. They might seem obscure and complex; as a result, most of the people skip investment in bond in UAE. Yet the bond funds also have a main role to play. So, let us see what exactly are bonds, and what can these funds do for you?
There are 2 major kinds of bonds- corporate bonds and National bonds UAE. They broadly work in the same way and get issued for the same reason, for raising money.
Typically, governments issue bonds for funding their spending on areas such as roads, defense, and schools. On the other hand, the companies are generally raising funds for the purpose of expansion.
Those who invest in bonds get rewarded with a regular payment of interest along with a promise of returning the original capital at a specific time in the future that can be anything ranging from a month to 30 years.
This implies that the bond funds are effectively IOU with the investors lending their funds to the issuing company or government.
The bonds are usually described as the investments of fixed-income because you receive a set rate of interest for a pre-defined duration.
The rate of interest being paid on a bond fund is known as coupon or yield. The date of maturity is when the money should be paid back.
For instance, you have invested $10,000 in a ten-year US Treasure, a kind of bond that is issued by the government of the US. At the time of writing it yields 2.36%. You would receive $236 in one year for ten years, and then your $10,000 at the time of maturity.
The majority of the investors don’t purchase government or corporate or individual bonds. They instead invest in bond funds. These are mutual funds, which are managed actively and invest in a range of different bonds for minimizing risk.
Some of the funds invest in government bonds, some in corporate bonds, while some of them offer a combination of both.
The fund managers develop a portfolio of bonds by paying different rates of interest, with varying risk profiles, and varying dates of maturity for providing a more balanced return.
The corporate bonds tend to provide the highest yields, usually, between 3 & 6% in one year, which is higher than what you receive on cash.
The more the interest is, the higher is the risk. Therefore, the relatively lower 2.36% return on those solid US Treasuries.
Opposite to this, when the Eurozone crisis was at its height in early 2012, the Greek bonds yield topped 40% briefly (they have fallen to about 5% since then).
At present, the 2-year bonds issued by Venezuela, the crisis-torn region, are paying an amazing 176% that reflects the tiny chance of you getting your funds back.
The investors must take bond funds into consideration as a part of a diversified and balanced portfolio. Bonds are comparatively less volatile than shares and stocks that help you in counterbalancing the swings in the stock market and protecting from the fall in the prices of shares.
Therefore, bonds are ideal for those investors who are cautious, especially those who are interested in preserving their capital. The investors having a low to medium risk investment portfolios will have a higher weighting in bonds. The government bonds show especially lower volatility.
The older you become, the more funds you must hold in your bonds as compared to shares, for protecting the capital that you have built up in your lifetime. Bonds may also be suitable for investors having a shorter horizon of say less than 5 years.
A lot of investors have skipped bonds in recent years, particularly government bonds because of the lower returns than the rising stock markets. However, though the bonds are not completely risk-free, they are usually considered to be a safer investment because they provide a fixed-income return.