Investment Guy

As investors, we have a variety of opportunities to determine where to place our money and ‘bet’ on the markets. For an aggressive investor, the stock market has been the venue of choice. For conservative investors, bonds have had the upper hand.

The famous cowboy/philosopher Will Rogers always said “I’d rather have a return of my money than a return on my money”  Hopefully this quick guide to bond risks will help you invest in bonds and receive not only a return on your investment, but more importantly, a return of your investment.

Over time, the markets have expanded their offerings from traditional holdings of stocks and bonds to more creative opportunities and higher risk assets. Still, bonds have not changed their stripes over the years. These have traditionally been stable, secure investments that have offered a predictable stream of supplemental income.  This is because a bond is issued with a fixed payment rate of return over a specified period of time- typically until the bond matures.

 However, there are still risks to consider. Let me name a few:

• Inflation Risk: Because of their relative safety, bonds tend not to offer extraordinarily high returns. That makes them particularly vulnerable when inflation rises.
• Interest rate risk: Bond prices have an inverse relationship to interest rates. When one rises, the other falls.
• Default Risk: A bond is nothing more than a promise to repay the debt holder. And promises are made to be broken. Corporations go bankrupt. Cities and states default on muni bonds. Things happen…and default is the worst thing that can happen to a bondholder.
• Downgrade Risk: Sometimes you buy a bond with a high rating, only to find that Wall Street later sours on the issue. That’s downgrade risk.If a credit rating agency such as Standard & Poor’s and Moody’s lowers their ratings on a bond, the price of those bonds may fall.
• Liquidity risk: The market for bonds is considerably thinner than for stock. The simple truth is that when a bond is sold on the secondary market, there’s not always a buyer. Liquidity risk describes the danger that when you need to sell a bond, you won’t be able to.
• Reinvestment Risk: Many corporate bonds are callable. What that means is that the bond issuer reserves the right to “call” the bond before maturity and pay off the debt. That can lead to reinvestment risk.

If you want some more information about how individual bonds are priced in your account, check out Bonds and Your Brokerage Statement.