Motley Fool: Investors could take another look at bonds

It’s often recommended that we own stocks and bonds for diversification. But as retirement nears, think harder about bonds.

Bonds are essentially loans: Investors lend money to companies, local governments or the federal government, and in exchange are typically promised interest.

The safer the bond issuer, the lower the interest rate: U.S. government bonds are considered very safe and tend to offer relatively low interest rates, whereas bonds from shaky companies are referred to as “junk bonds” and often use higher interest rates to attract buyers.

The old-fashioned way to invest in bonds was to buy individual bonds.

U.S. Treasury bonds are available at TreasuryDirect.gov, and you can buy most other bonds via a brokerage account.

But many people don’t feel confident enough to select bonds on their own, and they may not be planning to hold them until maturity, either.

A solid alternative way to invest in bonds is via a bond mutual fund or an exchange-traded fund (ETF) – a mutual fund-like security that trades like a stock.

One highly regarded bond ETF is the Vanguard Total Bond Market ETF (BND). It charges an ultralow “expense ratio” (annual fee) of 0.03% and recently sported a yield of 4.7%.

The Vanguard Total Bond Market ETF is highly diversified (different bond categories, sectors and maturities), as it encompasses more than 11,000 bonds, and roughly two-thirds of its holdings recently were U.S. government bonds.

So consider including bonds in your portfolio mix, especially if you’re approaching retirement.

(The Motley Fool owns shares of and has recommended the Vanguard ETFs we’ve shared here.)

Ask the Fool

Q. Is it OK if a company does a reverse stock split? – C.I., Syracuse, New York

A. It’s generally a red flag, as reverse splits are often executed by struggling companies.

With a regular stock split, you end up with more shares, priced proportionately lower.

But a reverse split does the opposite, propping up the stock price (which can make the company look better) while shrinking the number of shares.

Imagine Scruffy’s Chicken Shack (Ticker: BUKBUK), trading at $5 per share.

If you own 200 shares, they’re worth $1,000.

If the company executes a 1-for-10 reverse split, you’ll end up with 20 shares, priced around $50 each. The total value of your shares remains the same – $1,000 – both before and after the split.

All that happened is that the company increased its stock price by decreasing its number of shares.

Some reverse splits happen so companies can avoid being delisted from stock exchanges that require minimum price levels.

If you notice that a troubled company’s stock is suddenly trading at a much higher price per share, it might mean that a reverse split has occurred – not that the company has pulled off a remarkable turnaround.

Q. What’s “algorithmic trading”? – J.S., Gainesville, Florida

A. It’s when computers – not humans – are placing buy and sell orders in the market, and they’re doing so based on certain algorithms – sets of predetermined rules.

The aim is to make money via fast-paced and frequent trading. Algorithmic trading can influence stock prices and market volatility, which can also affect us small investors.

My dumbest investment

My most regrettable investing move was selling my shares of semiconductor company Nvidia too soon. – A.K., online

The Fool responds: Ouch. You didn’t say when this happened, but for illustration purposes, let’s say you bought around 10 years ago, in May 2014, paying roughly a $4.64 (split-adjusted) price per share.

If you sold five years later, when shares were trading around $39 per share (split-adjusted), you’d have enjoyed a gain of more than 780%, which was about 55% on an annualized basis. That’s excellent!

Of course, five years after that, Nvidia shares were trading near $950 per share.

If you still owned them, your total gain would have been around 21,000%, or more than 70% per year on average.

Nvidia has been one of the best performers in the past decade, and many expect continued growth from the behemoth, as it has expanded from specializing in gaming chips to much-in-demand artificial intelligence (AI) chips.

With great companies, it’s usually smart to simply hang on for many years, despite occasional downturns or sluggishness.

As long as you remain confident, hang on. If you’re not confident of the company’s growth prospects, though, selling can be the right move.