How Bonds Help Diversify An Equity-heavy Portfolio

By Author: Ravi Fernandes
Total Articles: 127
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When I look at my savings, I want to know how much depends on the stock market. I could own shares in ten companies and invest in three equity mutual funds. That may seem like a wide spread, but most of my money would still be in equities.
Adding bonds gives part of my savings a different role. To understand why that matters, I start with what I am buying.
Understanding bonds in simple words
When I buy a company’s shares, I own a small part of that business. When I buy its bond, I lend money to it.
The company borrowing my money is called the issuer. It agrees to repay me according to the bond’s terms. Many bonds also pay interest on set dates.
These payments depend on the issuer’s ability to pay. Before lending my money, I would want to understand the business and its financial position.
Giving my money different jobs
I might hold shares because I want my savings to grow over several years. Bonds can serve another purpose by providing scheduled payments and a date for repayment.
Having both means I do not depend entirely on one ...
... type of investment. However, bonds and shares can both lose value. Adding bonds helps spread risk, but it does not make my savings free from risk.
For me, the question is whether each investment serves a need.
Understanding the payments
Suppose I buy a bond with a face value of ₹1 lakh and an annual interest rate of 8%. If the issuer pays as agreed, I would receive ₹8,000 a year before tax.
The bond’s terms would tell me whether I receive this money monthly, quarterly or at another interval.
I would also check the buying price. Face value is the amount used to calculate the interest payment. If I pay more or less than that amount, my actual return changes.
Planning when I need my money back
Before buying, I would ask myself when I expect to use the money.
If I have an expense coming up in three years, I could examine bonds due for repayment around that time. I would check the details because some repay the money together, while others return it in parts.
I would keep emergency savings accessible. Selling a bond early may take time, and I might receive less than I paid.
Avoiding too much dependence on one company
Putting all my bond money into one company would leave me relying on that borrower.
My approach to bonds portfolio diversification would be to consider different companies, industries and repayment dates. I would also check whether I already own shares in those companies.
A credit rating can help me understand repayment risk. Still, I would read the bond’s terms and examine the issuer’s finances. A good rating is not a promise that every payment will arrive.
Choosing a mix I can understand
I would decide how much to put into bonds after looking at my expenses, goals and ability to bear losses. Someone needing money soon may choose a different mix from someone saving for a goal twenty years away.
The bond market offers different choices. Before choosing one, I would check the return, repayment risk and options for selling.
I would review my investments when my needs change. My aim would be to keep money for urgent expenses accessible, use suitable bonds for planned payments, and give my equity investments time to grow.