To the average observer, investing in bonds is simple. The general rule here is to buy the bond which has the highest yield. This does work well with the certificate of deposit with your local bank; however, it is not as simple as you think in real life. When it comes to structuring the bond portfolio, you will discover there are multiple options available for you. Every strategy comes with its risk and profit trade-offs. However, the four strategies that are used for managing bond portfolios are-
- Buy and hold or passive strategy.
- Quasi passive or index bond matching strategy.
- Quasi active or immunization strategy.
- Dedicated and active strategy.
Kavan Choksi -An insight into these four strategies
Kavan Choksi is an esteemed entrepreneur with expert business skills in financial management and investments. According to him, before you adopt any of the above four strategies, you first should know what they mean-
- Passive buy and hold– Here, the investor aims to optimize the income of the bonds. The basis of this strategy is the bonds are predictable and safe. The process involves the investor buying the bonds and holding them till maturity. The cash flow received from them can be used for external income requirements or reinvested in their portfolio, other asset classes, or more bonds.
- Indexing bond- By design, this strategy is said to be quasi-passive. The main goal of indexing the bond portfolio is to offer the investor risk and return traits associated with the index in question. This strategy has some of the characteristics of the first one discussed here. However, it has some level of flexibility, like tracking a certain stock market index. It can also be structured in such a way to mimic any bond index that has been published. One example of the above is The Barclays US Aggregate Bond Index, a common index that managers have mimicked.
- Immunization strategy– This strategy has the traits of both the passive and the active strategies. This means immunization matches the duration of the liabilities and the assets (like discounted cash flows in the future needed by the portfolio) for protection against fluctuations in the interest rates.
- Active bond strategy– The goal here is to optimize the total returns. However, along with thesereturns comes a lot of risks as well. Some examples of the above cover anticipation of interest rates, spread exploitation, scenarios for multiple interest rates, and more. The fundamental rule here is that the investor is ready to place bets for the future over settling down with low returns that the passive strategy offers.
According to Kavan Choksi, every strategy has its pros and cons. However, being aware of them largely helps you to enjoy profits in the long run. It is important for you to understand how many risks you can take before investing in bonds so that you can make prudent choices without worrying about your financial future! You should always consult an investment advisor to help you choose the right strategy for wealth building.