Page 127 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Personal Financial Planning

Notes more sensitive to changes in interest rates however, so there is some risk if you need to sell them
before their maturity date. It is also best to buy taxable (as opposed to municipal) zeros in a
tax-deferred retirement or college savings account because the interest that accumulates on the
bond is taxable each year even though you do not receive it until maturity.
A bullet strategy can also help you invest for a defined future date. If you are 50 years old and
you want to save toward a retirement age of 65, in a bullet strategy you would buy a 15-year
bond now, a 10 year bond five years from now, and a five-year bond 10 years from now.
Staggering the investments this way may help you benefit from different interest rate cycles.

Reasons you might Sell a Bond before Maturity

Investors following a buy-and-hold strategy can encounter circumstances that might compel
them to sell a bond prior to maturity for the following reasons:

1. They need the principal. While buy-and-hold is generally best used as a longer-term
strategy, life does not always work out as planned. When you sell a bond before maturity,
you may get more or less than you paid for it. If interest rates have risen since the bond
was purchased, its value will have declined. If rates have declined, the bond’s value will
have increased.
2. They want to realize a capital gain. If rates have declined and a bond has appreciated in
value, the investor may decide that it’s better to sell before maturity and take the gain
rather than continue to collect the interest. This decision should be made carefully, as the
proceeds of the transaction may have to be reinvested at lower interest rates.

3. They need to realize a loss for tax purposes. Selling an investment at a loss can be a
strategy for offsetting the tax impact of investment gains. Bond swapping can help achieve
a tax goal without changing the basic profile of your portfolio.
4. They have achieved their return objective. Some investors invest in bonds with the objective
of total return, or income plus capital appreciation or growth. Achieving capital
appreciation requires an investor to sell an investment for more than its purchase price
when the market presents the opportunity.

Total Return

Using bonds to invest for total return, or a combination of capital appreciation (growth) and
income, requires a more active trading strategy and a view on the direction of the economy and
interest rates. Total return investors want to buy a bond when its price is low and sell it when the
price has risen, rather than holding the bond to maturity.
Bond prices fall when interest rates are rising, usually as the economy accelerates. They typically
rise when interest rates fall, usually when the RBI Reserve is trying to stimulate economic
growth after a recession. Within different sectors of the bond market, differences in supply and
demand can create short-term trading opportunities.
Various futures, options and derivatives can also be used to implement different market views
or to hedge the risk in different bond investments. Investors should take care to understand the
cost and risks of these strategies before committing funds.
Some bond funds have total return as their investment objective, offering investors the
opportunity to benefit from bond market movements while leaving the day-to-day investment
decisions to professional portfolio managers.

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