6 Bonds, Money-Market Instruments and Other Underlying Assets


Bonds, often called fixed income securities or simply fixed income, are debt obligations. The issuer, usually a company or government, is bound to pay, to the holder, a number of installments (coupons) that were defined when the bond was created. The difference with a certificate of deposit or a common loan, is that the holder can easily trade this right, by selling the security to someone else. Thus, the bond has a market value, which fluctuates according to the profitability of other investment opportunities and the financial health of the issuer. Nevertheless, these fluctuations are not as high as those of company stock, because bond returns are not tied to such an uncertain element as company earnings.

Therefore, an all-stock portfolio can be made more diversified and less volatile by adding fixed income or, even better, fixed-income funds. Just as with stock, there are several criteria for classifying bonds and studying the diversification level of fixed-income funds. If the issuer's commitment is long term, then the price of the bond will be more susceptible to variations in the profitability of alternative investments. On the other hand, fixed income from smaller companies, or companies in financial difficulties, tends to be more profitable but is also more risky. It is therefore useful to study what investors call the duration and credit quality of the bonds in the fixed-income funds we may purchase, so as to evaluate their level of diversification and risk.

Money-market instruments

Another kind of asset that may be present in your portfolio are money-market instruments. These are safe non-volatile instruments with low profitability, that are very liquid (liquidity is the quality of turning an investment into cash easily and fast). They are therefore usually called cash equivalents. Money-market funds and accounts are generally used for parking money, earning a little while doing so. Focused traders used them often, to reserve cash in case an opportunity appears, or when speculating on a market downfall. Diversified long-term investors don't use them that much, but there are cases when your portfolio does have a small portion in cash, hence money-market instruments become handy too.

Other assets

Other asset classes that you may make use of, although not as often, are commodity and real-estate funds. Commodities are widely-traded goods that, unlike other merchandise, are not differentiated by qualities such as brand and model name. For example, gold, oil and wheat. It is hard to predict the future prices of commodities. Besides, unlike stock and bonds, it is not clear that holding ownership of commodities is providing a service to anyone. Therefore commodity funds are rarely used by diversified buy-and-hold investors.

Real estate investment trusts (REITs) and funds of REITs are used more, to diversify a small part of a stock-and-bond portfolio through real-estate property and mortgages.

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