Access the unprecedented potential of bond investing! Bonds have come a long way in recent years. No longer just a relatively safe and secure investment, bonds now offer the potential for capital appreciation in addition to interest income. All About Bonds, Bond Mutual Funds, and Bond ETFs is the key to understanding both traditional and new types of bond investments. This detailed but accessible introduction covers everything from basic bond characteristics to fixed-income investment techniques. You'll gain a thorough education on such topics as yield, liquidity, duration, convexity, valuation, and emerging markets and find the answers to many questions a bond investor will ask, such as: What percentage of my portfolio should be dedicated to bonds? - What are the newest products and where do I find them? - What are the risks involved with investing in bonds, bond mutual funds and bond ETFs? - How can I use the Internet to my advantage? Whether you're involved in the bond market already or about to enter it, All About Bonds, Bond Mutual Funds, and Bond ETFs will guide you though the process of choosing the best bonds for your needs, evaluating their performance, and managing a bond portfolio. Esmé Faerber is a professor of business and accounting at Rosemont College. She is the author of All About Stocks and All About Investing . Esmé Faerber is a professor of businessand accounting at Rosemont College. She is the author of All About Stocks and All About Investing . ALL ABOUT BONDS, BOND MUTUAL FUNDS, AND BOND ETFs By ESMÉ FAERBER The McGraw-Hill Companies, Inc. Copyright © 2009 Esmé Faerber All right reserved. ISBN: 978-0-07-154427-6 Contents Chapter One What Bonds Can Do for You and Why You Should Consider Investing in Them KEY CONCEPTS * Reasons for investing in bonds * What are bonds? * Terminology of bonds * How to buy and sell bonds History provides not only insights into past returns from investing in the stock and bond markets, but also valuable lessons for investing in the future. Evaluating the performance of stocks and bonds can provide you with insights into planning your investments for the future. Advocates of stock investments quote historic returns over long periods of time, such as 20-, 50-, and 100-year periods because stocks have consistently outperformed bonds and other financial asset classes. However, when the time frame falls to shorter time periods (less than five years) the results can be markedly different, as Table 1-1 illustrates. The performance of bonds over two- to five-year periods has often outperformed the returns of stocks and money market securities (cash equivalents). Within these shorter time frames, there are at least two sets of circumstances where bonds outperform stocks. During recessions, bonds generally provide better returns than stocks, and when both interest rates and inflation are rising, short-term bonds (Treasury bills and money market equivalents) often outperform both long-term bonds and stocks. An example illustrates the risk of loss from investing in only one asset class. If you had invested solely in stocks in the time period from March 1995 through March 2000 you would have earned spectacular returns, as the U.S. stock markets reached their all-time highs in March 2000. During that time period, other financial securities such as bonds and money market securities could not match the stellar stock market returns. However, for the following two and a half years, the broad stock market index fell by 50 percent, and technology stocks declined by roughly 80 percent, while bonds earned positive returns. For the next two and a half years through March 2005, the stock markets increased but they came no where near the highs of March 2000. If you were clairvoyant you would have invested solely in stocks from 1995 to 1999, switched to bonds January 1, 2000, through 2002, and then switched back to stocks in 2003 through 2004, and your returns would have been hard to beat. The problem is that we do not know when we should be fully invested in stocks and when we should switch to bonds. The lessons that we can learn from this example are: * It is virtually impossible to determine how the markets will perform in the future and so we should not have all our eggs in one basket, so to speak, by investing solely in stocks or bonds. We want to minimize the risk of loss. * The key to minimizing the risk of loss is to invest in different classes of investments whose returns are not correlated—in other words, investing in asset classes whose returns do not rise and fall together. When one asset class declines in value, another asset class increases, which minimizes portfolio losses and seeks positive overall returns. The concept of minimizing the risk of loss through asset allocation can be illustrated further by examining Figure 1-1 . In the 10-year period from 1995 to 2004, large- cap stocks earned on a