Diversification of bond funds can help reduce risk and increase consistency over time
Fixed-income performance reversals are common: It is extremely difficult to predict which category of bonds will be the best or worst performer in any given year. The performance of any fixed-income investment can have drastic periodic changes. Investors could potentially diminish their returns by attempting to follow last year’s winner.
Furthermore, investors who have an asset allocation policy consisting of different asset classes such as stocks and bonds may still not be diversified. Therefore, branching out within each asset class may further lessen overall portfolio risk.
Diversified bond funds might alleviate portfolio volatility: The image illustrates the performance of various fixed-income instruments in relation to one another from 2002 to 2011. The data shows it is impossible to predict the winners for any given year. For example, high-yield corporate bonds were the worst performers in 2007 and 2008, but rose to become the best-performing investment in 2009 and 2010. While aggregate bonds have never been the top performer in any of the years examined, their performance has remained fairly consistent, with minimal swings when compared with other categories such as long-term and international bonds.
It can be beneficial to hold a fund that is diversified across several types of bonds. This might reduce portfolio risk while allowing for more consistent performance over time.
Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. Diversification does not eliminate the risk of experiencing investment losses. Government bonds and Treasury bills are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest. With corporate bonds, an investor is a creditor of the corporation and the bond is subject to default risk. High-yield corporate bonds exhibit significantly more risk of default than investment grade corporate bonds. Municipal bonds may be subject to the alternative minimum tax (AMT) and state and local taxes, and federal taxes would apply to any capital gains distributions. International bonds are not guaranteed. International investments involve special risks such as fluctuations in currency, foreign taxation, economic and political risks, and differences in accounting and financial standards.