Are bonds right for you? Q&A with Betterment Investing
We sat down with Betterment Director of Investing Mindy Yu to have her explain what bonds are and if they are right for your investing goals.
Question 1: What's the difference between bonds and stocks?
Mindy: A stock represents a share of ownership in a company. Depending on how a company performs, the stock value can rise and fall.
A bond is like a loan that you provide to an entity such as a business or government. The entity issuing the bond promises to pay your money back by some specified date (called the bond’s maturity), plus interest that is typically distributed to you on a consistent schedule, such as on a monthly, quarterly, semi-annual, or annual basis.
Question 2: Are there risks to investing in bonds?
Mindy: First, all investing involves risk. However, bonds have historically been less risky than stocks—but keep in mind with less risk typically comes a lower return on your investment over time.
Two common risks associated with bonds are credit risk, the likelihood of a bond issuer paying you back, and interest rate risk, a bond’s sensitivity to changes in interest rates. Bond prices and interest rates historically have moved in opposite directions, as one rises the other falls.
Question 3: What are the different types of bonds?
Mindy: Some common types of bonds that can be used to create a portfolio include:
- Investment-grade bonds: These are bonds issued by relatively more creditworthy (less risky) entities. Because they are less risky, these bonds typically have lower interest rates and thus lower income potential.
- High-yield bonds: These are bonds issued by relatively less creditworthy issuers and because they are less creditworthy, these issuers’ bonds typically carry higher interest rates and enhanced levels of potential income.
- Treasury bonds: These are bonds issued by the U.S. government which is considered to be one of the most creditworthy issuers. Treasury bonds include T-bills (0-1 years to maturity), Treasury notes (1-10 years to maturity), and Treasury bonds (10-30 years to maturity).
Question 4: How do I know if I should invest in bonds?
Mindy: There are a few financial goals that bonds may be suited for:
- Diversification: If you own stocks, bonds could help reduce volatility. This is because the values of stocks and bonds have historically moved in opposite directions. When one rises, the other typically falls.
- Consistent income: If you are looking for income, bonds may be able to help. This is because the entity issuing a bond typically pays the bondholder interest on some regular schedule.
- Putting cash to work: If you are looking to preserve the value of your savings, while potentially earning some return over a traditional savings account or CDs, bonds, especially short-maturity bonds, may be a viable option.
Question 5: Betterment offers the BlackRock Target Income portfolio. How does it work?
Mindy: The BlackRock Target Income portfolio offered by Betterment is built with a diverse set of bond ETFs. Let’s break down what that means:
- A bond ETF may contain hundreds, sometimes thousands of bonds, and offer broad or targeted exposure to various areas of the bond market without the investor needing to invest in the bonds directly.
- The BlackRock Target Income portfolio includes a diverse set of bond ETFs with a range of risk levels, helping to mitigate exposure to volatility in the stock market, aiming to preserve wealth, while seeking to generate income.
- All interest payments, also called dividends, are automatically reinvested to help grow the portfolio’s value.
Question 6: Who is the portfolio best suited for?
Mindy: Because the BlackRock Target Income portfolio is 100% invested in bond ETFs, it may be better suited for investors with a relatively lower risk tolerance and shorter investment time horizon. This could include investors closer to retirement or with short-term goals.
As you decide which investments are right for your goals, keep in mind that while bonds are a lot less volatile than stocks, investing in them is not without risk.