The main source of investment income in the past - BONDS

When people speak of income investing they usually associate it with Fixed Income investments, or Bonds. Although bonds were heavily used for income in the past, they are slowly beginning to get out of favour nowadays due to the trend of decreasing interest rates. Don't get me wrong, Bonds are still a good source of steady income, and are less votatile than stocks.

We all know the inverse proportionality affecting Bond prices against interest rates. There are few risks associated with Bonds, namely: Interest Rate Risk, Credit Risk, Purchasing Power Risk, Marketability Risk, Liquidity Risk, Reinvestment Risk, Call and Event risk etc.

But the risks that affects Bond investors the most today is Interest Rate Risk, Purchasing Power Risk and Reinvestment Risk.

To put it simply, Interest Rate Risk is the risk that the bond(s) that you are holding prices drop due to an increase in interest rates. The bond(s) that you hold will be less attractive than the newer offered bonds, as a result you will need to sell your bond at a discount to the par price. But this would not affect those who hold their bonds to maturity.

Purchasing Power Risk is the risk you battle with inflation. For example, the $1000 bond you bought today may be valued at only $940 when it matures. Therefore, if the yield of the bond isn't high enough, inflation will erode away any profits gained, or worst still cuts into the amount you paid for the bond.

Thirdly, Reinvestment Risk. Reinvestment Risk is a common risk Fixed Income investors faced when they are not able to reinvest their bond(s) at an interest rate similar to or higher than the earlier bond(s).

Here are some suggestions on how to cope with Bond Risks:

• Interest Rate Risk: Buy Short-Term maturity bonds, Laddering.
• Purchasing Power Risk: Buy TIPS, Short-Term maturity bonds.
• Reinvestment Risk: Longer Maturity bonds.

*Remember to diversify your bond investments.