If you're the risk-averse type who truly can't bear the thought of losing money, bonds might be a more suitable investment for you than stocks. If you're heavily invested in stocks, bonds are a good way to diversify your portfolio and protect yourself from market volatility. If you're near retirement or already retired, you may not have the time to ride out stock market downturns , in which case bonds are a safer place for your money. In fact, most people are advised to shift away from stocks and into bonds as they get older, and it's not terrible advice, provided you don't make the mistake of dumping your stocks completely in retirement.
A municipal bond is a debt issued by a state or municipality to fund public works. Like other bonds, investors lend money to the issuer for a predetermined period of time. The issuer promises to pay the investor interest over the term of the bond usually twice a year , and then return the principal back to the investor when the bond matures.
A Treasury bond is debt issued by the U. Technically speaking, every kind of debt issued by the federal government is a bond, but the U. Treasury defines the Treasury bond as the year note. Generally considered the safest investment in the world, U.
Treasury securities of all lengths provide a nearly guaranteed source of income and hold their value in just about every economic environment. A corporate bond is a debt instrument issued by a business to raise money.
Unlike a stock offering, with which investors buy a stake in the company itself, a bond is a loan with a fixed term and an interest yield that investors will earn. When it matures, or reaches the end of the term, the company repays the bond holder. Investing Best Accounts. Stock Market Basics. Stock Market. Industries to Invest In.
Getting Started. Planning for Retirement. Retired: What Now? Personal Finance. Credit Cards. About Us. Who Is the Motley Fool? Fool Podcasts. And as you learned earlier, interest rates and bond prices are inversely related. Thus, higher inflation usually lends itself to lower bond prices. But inflation also has another dagger to throw at bonds…. The other negative consequence of inflation or Hyperinflation in some rare instances is negative purchasing power.
In general, when inflation goes up, so does everything in else in terms of consumer prices, goods, services, etc. In other words, your bond investment is now losing money in regards to true purchasing power. These are usually short-term bonds that have a hedge against inflation. But keep in mind that these can be very interest rate sensitive, so if we never experience inflation, or even worse, we have deflation, these can actually hurt you as well.
Well one of the consequences to a slowing economy is that interest rates can slow down as well. And when the interest rates decline, bond investors are forced to reinvest their bond interest and any return of principal into new securities that will have lower rates of return. Of course this will reduce the overall income that is being generated by your bond portfolio. The big takeaway here is that reinvestment risk is greatest for bonds with higher coupon or interest payments.
And of course this risk is only pertinent if interest rates go down, which is the opposite of most of the other bond risks. Overall, bond mutual funds have can experience the same kinds of risks that we have covered so far such as credit risk, inflation risk, creditworthiness, etc.
But because the bond fund contains numerous individual bonds that are all expiring and held for different times and purposes , these risks are usually pretty well spread out. However, it is that same bond fund design of having different bonds expire aka mature at different times to create a nice income stream for investors that never ends that can present some compounding problems down the road. Here is what occurs. As the bond fund manager starts replacing bonds as they mature in a rising interest rate environment which means bond prices are falling , the net asset value NAV and the return on the bond fund fall as well.
And although that might seem bad enough that the entire bond fund portfolio will lose value, the real pain comes when investors all start leaving the fund in droves during times of panic. When this happens, the bond manager is forced to start unloading some of the bond holdings early to meet redemptions, which can really hurt the overall bond fund.
Especially if the manager is forced to sell some of the highest yielding bonds first and then have to replace them later with lower yielding bonds. The takeaway here is to always stay up to date and educated on what is going on within your bond fund. You do not want to be the last one to find out about a big shift or sell-off in your fund.
You could wake up one day with an entirely different looking bond fund than you originally purchased. Because when you hear about people losing some, most, or even all of their money in bonds, it is rarely the bond trader on Wall Street. Instead, it is the average trader with a day job that made the false assumption that their bonds and bond income were safe and never needed to be reviewed.
And by the time you realize that there is a big problem, it is already way too late. And stay educated! Stay up to date on latest bond news, watch interest rates like a hawk, and work with a financial professional that specializes in bonds. Disclaimer: Nothing in this article should be or can be construed as investment advice.
This is simply educational and is not intended to be advice. Nor is there enough information contained in this article to make a sound investment decision. By submitting your email you agree to receive newsletters, updates, and other emails from our team. You understand you may unsubscribe at any time. Bethany works remotely from her home in SW Missouri. She has been working and assisting in investment and insurance services since She is a dedicated and valued asset to our team as Director of Client Services.
In turn, you get back a set amount of interest once or twice a year. If you hold bonds until the maturity date, you will get all your money back as well. Examples: corporations, investment trusts and government bodies. Also, the period of time that an investment pays a set rate of interest. The term can be anywhere from a year or less to as long as 30 years. In return, the issuer pays you interest. On the date the bond becomes due the maturity date Maturity date The date when an investment becomes due.
On that date, you get your money back without any penalty. Any interest payments stop. Most bonds have a fixed interest rate Interest rate A fee you pay to borrow money. Or, a fee you get to lend it. Examples: If you get a loan, you pay interest.
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