When building a portfolio, it is important to look for balance in terms of the types of assets you purchase. While stocks are often viewed as more exciting, that doesn’t mean bonds can’t play an important role in building your investment base, even if you’re younger and generally more interested in an aggressive strategy. This is especially true if you look for premium bonds, which can provide protection against external factors, namely rising interest rates. Some experts, including those at financial giant Fidelity, say now is a great time to look to premium bonds.
For help investing in premium bonds or with any other financial planning questions, consider getting professional advice using SmartAsset’s free financial advisor matching service.
Bonds and Premium Bonds, Defined
When you buy a bond, you’re essentially lending money to a company or municipality in exchange for a promise that the money will be paid back later with interest. Bonds are defined as fixed-income investments as you know exactly how much money you’ll be getting back. Bonds are generally seen as lower-risk but lower-reward investments compared with stocks, and are especially popular with older investors who may not want to risk as much of their principal as they approach retirement.
A premium bond is a bond that is sold on the secondary market for higher than the original price. This means someone has purchased the bond from the issuer and is selling it to a new investor, making money on the excess. This is in contrast to discount bonds, which are sold on the secondary market for less than the original price.
Why Premium Bonds May Be Good for Your Portfolio
The Federal Reserve is poised to raise interest rates from the historically low rates that came at the beginning of the COVID-19 pandemic. Generally, higher interest rates is bad for bond investors. A report from Fidelity, though, points out that premium bonds are less susceptible to that pressure.
“Premium municipal bonds have the potential to oﬀer some protection for investors’ portfolios as interest rates rise,” the report reads. “Premium bonds oﬀer a cushion against the risks posed by interest rate changes because they pay more interest (and sooner) than non-premium bonds do and their prices have historically been less sensitive to rising interest rates. The benefits of premium bonds have long been understood by sophisticated institutional investors but individual investors can also gain exposure to them in separately managed accounts.”
The following table is based on data from Fidelity Investments.
Premium Bonds Compared to Non-Premium Bonds With Identical Face Value & Duration
|Financial Metric||Discount Bond||Face Value Bond||Premium Bond|
|Annual interest paid||$200||$265||$500|
|Effective duration||9.08 years||8.85 years||8.2 years|
Ryan C. Unthank, a CFA at The Popovich Financial Group, agrees with the Fidelity report.
“Savvy bond investors are able to understand why premium bonds may provide valuable
diversification in a bond portfolio,” he notes. “They are able to mitigate risks and provide adequate returns by using different strategies in seeking to enhance value. All of these factors help to explain why premium bonds may provide premium value.”
How to Invest in Premium Bonds
There are a number of ways you can invest in premium bonds. You could buy them directly, though this takes a bit of know-how. If you’re going to buy premium bonds by yourself, make sure you do plenty of research.
Another way is to work with a financial advisor. An advisor can help direct you to the right premium bonds for your situation and make sure you are getting what you need.
Finally, consider buying into a separately managed account, mutual fund or exchange-traded fund that invests in premium bonds. This gives you exposure to these investments without having to directly buy the products.
The Bottom Line
With interest rates set to rise, premium bonds may provide you some cover. Premium bonds are secondary market bonds trading above their original price, and they are less impacted by rising interest rates. Consider buying them directly, working with an advisor or investing in a fund that buys premium bonds.
- If you want someone to help you build a safe, lucrative portfolio, consider finding a financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Want to see what your investment will be worth in the long-run? Look into a possible future with SmartAsset’s free investment calculator.
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