Bond investing looks simple. Many novices would think that you simply buy the bond that has the highest yield. However, this may work when purchasing certificates of deposit it is not really a simple as that. Several options are available to the bond purchaser. Each strategy in forming the bond portfolio has benefits and pitfalls. The four main strategies professionals use to manage bond portfolios are: the passive strategy, the index matching strategy, the immunization strategy or the dedicated and active strategy.
Using the passive bond strategy, also known as the buy and hold, indicates that the investor wants to create the most income possible through generating the ownership of more bonds. The strategy assumes that the investments are safe and predictable for income purposes. Passive strategies require the bonds be held until they mature. The cash flow derived form the bonds are used to fund other needs or some people choose to reinvest the income. The investor is not required to make assumptions about the direction of interest rates in the future and the current value shifting of the bond is not important. The bond might be purchased at a discount rate and the full value is paid when it matures. The coupon yield can vary if reinvestment of the coupons is applied. Passive bond portfolios seem to be for lazy investors but in fact they are suited to smart investors. The passive bond portfolios are stable in unstable economies. The transaction costs are minimized or eliminated. If they are purchased when interest rates are high they may outperform most active investment strategies.
Passive bond investing is stable because they work best with high quality bonds that are non-callable such as investment grade corporate or government bonds, municipal bonds also fit these categories. The non callable bonds are suited for the passive strategies because of the small risk associated with changing the income streams.
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