Bonds can play an important role in your portfolio.
In its simplest form, a bond represents a financial obligation to pay a specified sum of money at specified future dates. Bonds are typically issued by governments and corporations. The issuer promises to make payments, which consist of interest in the form of regular coupon payments, and principal, which represents repayment of the initial amount borrowed.
Bonds can serve many purposes for investors. They can provide a predictable source of income, help preserve capital, and add attractive diversification benefits to an investment portfolio as they tend not to move in the same direction as other asset classes.
Fixed income mutual funds can provide investors with access to a diversified portfolio of bonds for a relatively small initial investment. They also offer professional investment management, liquidity and monthly income distributions.
Although less prone than equities to large changes in value, bonds are subject to risks of their own.
Interest-rate risk is a primary risk facing investors in the bond market, and is explained by the inverse relationship between the yield required by the market and current bond prices. The price of a typical bond will change in the opposite direction of the change in interest rates (i.e. bond prices fall as yields rise).
Consider an existing bond with a coupon rate of 5%. If interest rates rise, any newly issued bonds will offer a higher coupon rate, for example 5.5%. The 5% bond will be less appealing to new investors and consequently its price will drop in order to remain competitive with the newer, higher-coupon bond.
Since the price of a bond fluctuates with market interest rates, an investor faces the probability that prices will decline in a rising interest-rate environment. The silver lining in this scenario is that coupons received from existing bonds can be reinvested in newer bonds at higher rates.
This information has been provided by RBC Global Asset Management Inc. (RBC GAM) and is for informational purposes only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. The information contained herein is from sources believed to be reliable, but accuracy cannot be guaranteed. Please consult your advisor and read the prospectus or Fund Facts document before investing. There may be commissions, trailing commissions, management fees and expenses associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. RBC Funds, BlueBay Funds and PH&N Funds are offered by RBC Global Asset Management Inc. and distributed through authorized dealers.
® / ™ Trademark(s) of Royal Bank of Canada. Used under licence. © RBC Global Asset Management Inc. 2017
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