Top 6 Uses For Bonds

Individuals and institutions can use bonds in many ways: from the most basic, such as for preserving principal or saving and maximizing income, to more advanced uses, like managing interest-rate risk and diversifying a portfolio.

Bonds can also be an afterthought, especially during flight-to-quality events, when investors flock to the safest bonds they can find to weather financial storms. In fact, bonds are much more complex and versatile, and can provide investors with a variety of options. (To learn more, read our Bond Basics Tutorial.)

One of the most common uses of bonds is to preserve principal. While this concept works best with bonds that are perceived to be risk-free, like short-term U.S. government Treasury bills, investors can apply it to other types of bonds as well.

Barring any catastrophic events, bonds are effective in preserving principal. Because bonds are essentially loans with scheduled repayments and maturities, lenders (bondholders) can expect their bonds to retain value and terminate at par upon maturity. (For further reading, see Common Mistakes By Fixed-Income Investors.)

Individuals commonly use bonds to match a future expected cash need. Institutions also use this strategy on a more complex basis called immunization. The concept assumes a match of the duration of the bond to the expected cash flow, which can be easily accomplished by using a zero-coupon bond in which the maturity matches the bond's duration. However, this will not provide any income over the life of the bond. Read Immunization Inoculates Against Interest Rate Risk to learn more about this concept.