The individual bonds in our portfolio also declined in value. However, since we were planning hold them to maturity, we expected to get 100% of our principal returned. In the meantime, we will continue to get 4 to 5% annual yields. Thus, it didn't matter the market value was lower in the short term, unless the bond was going to default, which is not very likely for the municpal bonds and CDs (which are treated like bonds in my brokerage accounts).
The downside of individual bonds is that there is less financial flexibility. The minimum investment is $1000 for CDs and $5000 - $10,000 for municipal bonds. The default risk is also higher for a single municipal bond, especially since bond insurers may not be able to cover losses. Finally, there is less liquidity, since selling a CD or bond before maturity often has to be done below the purchase price.
Here's what I do when owning individual bonds and CDs:
- Own high quality municipal bonds and FDIC insured CDs. For municipal bonds, I try to stay with double A and Triple A that are insured, for what ever that's worth. Virtually all CDs are FDIC insure, make them relatively risk free for default.
With the likely increase of corporate bankruptcies, I am currently staying away from corporate bonds.
- Diversification. I typically limit the maxium amount of any issue to $10,000. That way if there is a default or bank failure, a maximum of $10,000 is at short term risk.
- Short maturities. Most of the bonds and CDs mature in 5 years or less. In a moment of weakness, I did buy three callable bonds with attractive yields at 20 year maturities. One has already been called due to declining interest rates. I expect the other two will eventually also be called.
- Laddering of maturities. I typically distribute the bond investments evenly across a five year time period. It enable me to hedge against both falling and rising interest rates, since 20% of the bond portfolio matures each year. Thus, if interest are falling, 80% of the portfolio is still invested at higher interest rates. If interest rates are rising, I have 20% of the portfolio to reinvest at the higher rates.
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This is not financial or investing advice. Please consult a professional advisor.
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