Bonds have been a preferred investment for the more conservative lot. Being a fixed-income investment, most investors prefer to buy bonds and leave them untouched until maturity. The trading of bonds is certainly not as actively volatile as stock trading, but market conditions permitting, it can actually yield decent returns. It's time to start reviewing your long-term investments and begin to reap profits out of them.
Bond swapping takes place in two steps. First, you must sell a bond, and second, you must utilize the funds obtained from the sale to purchase a bond or bonds with different features. The idea behind it is to gain from interest changes or lower your tax, and boost your investment portfolio.
Advantages of Bond Swapping
Volatile markets force investors to reassess their investment policies. Very soon, wise investors begin to explore options which not only help them make profits, but also keep the losses restricted to a bare minimum. Bond swapping is one such strategy, and here are its benefits.
Reduce Taxes
Among the several benefits of bond swapping, the foremost one makes you save on taxes. When you own a bond that is currently trading below the purchase rate, it makes sense to sell it. The loss incurred by this transaction will help you write-off payable taxes on gains from other investments. The proceeds from the sale can be used to purchase other bonds. Let's say you have tax-free municipal bonds in your state of residence, and then decide to move to another state. A bond swap will seem logical in such a scenario, as you'd be saving on the out-of-state taxes that you'd have to otherwise pay if you decide to keep the bonds. The funds received can be reinvested in bonds in your new state. There are times when the tax laws are altered which affect your investments, and you must not waste the opportunity to reap gains or minimize losses from it. Make sure to discuss this with your investment advisor.
Increase Returns
The basic purpose of investing money is to gain returns, and bonds are no exception. There are several strategies of bond swapping that will help you make the most out of your investments, and increasing the term is one of them. Long-term bonds yield better returns, so swapping your short-term ones for these makes sense. Keep in mind that extending the maturity will make your investment susceptible to interest rate fluctuations. Similarly, bonds that have a low credit rating yield better. Although this could be risky, some investors do downgrade in order to make a quick buck.
Increase Call Protection
Investors are given the right to 'call in' or redeem their bonds before they mature. The period between the date of purchase and the redemption date is referred to as call protection. Selling a bond with a short call-in date to buy one with a longer call-in date will result in better call protection for the investor. The investor can thus be shielded from the risk of reinvesting in sluggish market conditions.
Resist Market Fluctuations
Anticipating interest rate changes will always keep you a step ahead of market fluctuations. If you sense an increase in the rate of interest, lowering the maturity will help. Short term maturities will protect your portfolio from any future declines. On the other hand, if the markets indicate a dip, investing in bonds with longer maturity periods will lock in the higher interest rates before the plunge takes place.
Improve Quality of Investments
The credit rating of a bond determines its quality. As mentioned before, long-term bonds rank high on the credit ratings list, and are certified safe investments. But, to keep up with the changing markets, investments must also be altered accordingly. Market rates should dictate investment decisions, so as to yield maximum profits. Of course, it goes without saying that any transactions involving low rated bonds must be conducted with caution.
Investments, as a rule, must be studied thoroughly before you actually put your money in. While bond swapping may seem as a decent solution to end your investment woes, as a crafty investor you must always consult your investment advisor before implementing any ideas.
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