Editor: Crass Cash
Contrary to what the financial gurus tell you. You can lose money in bonds. There are plenty of ways as a matter of fact...
Interest Rates increase: bond prices and bond interest rates move in opposite directions. This may be one of the most important things you will ever hear when it comes to bond investing. If you own a $1,000 bond at par value yield 3% and the going interest rate for that bond goes up by 1%, then your $1,000 bond is now worth less. Why? Because you have to entice somebody to buy that bond since they can get a higher yield somewhere else. If you hold the bond to maturity though you will get your $1,000 back.
Bond funds: Bond funds are essentially a conglomerate of different bonds with different maturities. If rates change than you could still be holding a loss if that fund has too many that mature on a certain date. They try to stagger them, but you can still get caught with a loss if the bond market moves too much one way or another.
Credit downgrade: If you own any bond and the credit rating agencies downgrade the credit worthiness of the underlying company or country than your bond will fall in value. Unless of course you're the USA govt, in which case a few years ago this happened and then the yield actually fell. Go figure!
Lack of Liquidity: If you're looking to sell your junk bonds during a liquidity crisis than you're either not going to be able to sell them or you're going to have to do it at a severe discount. Don't think this can happen? Just look at the fall of 2008. Treasuries (US govt bonds) on the other hand never have this problem. They're the most liquid and efficient security market in the world.
Inflation increase: If inflation increases and you're stuck with a bond that has a fixed rate, then you're SOL. Your real rate of return is how much interest you receive above inflation. When inflation increases then your real rate of return goes down.
Reinvestment: You could say this encompasses all of the above. As you receive dividends and you need to reinvest them all of the above could penalize you. Especially if the bond is called (paid off) early.
If you're looking for a great book on bonds, I'd suggest: Bonds: The Unbeaten Path to Security.
Interest Rates increase: bond prices and bond interest rates move in opposite directions. This may be one of the most important things you will ever hear when it comes to bond investing. If you own a $1,000 bond at par value yield 3% and the going interest rate for that bond goes up by 1%, then your $1,000 bond is now worth less. Why? Because you have to entice somebody to buy that bond since they can get a higher yield somewhere else. If you hold the bond to maturity though you will get your $1,000 back.
Bond funds: Bond funds are essentially a conglomerate of different bonds with different maturities. If rates change than you could still be holding a loss if that fund has too many that mature on a certain date. They try to stagger them, but you can still get caught with a loss if the bond market moves too much one way or another.
Credit downgrade: If you own any bond and the credit rating agencies downgrade the credit worthiness of the underlying company or country than your bond will fall in value. Unless of course you're the USA govt, in which case a few years ago this happened and then the yield actually fell. Go figure!
Lack of Liquidity: If you're looking to sell your junk bonds during a liquidity crisis than you're either not going to be able to sell them or you're going to have to do it at a severe discount. Don't think this can happen? Just look at the fall of 2008. Treasuries (US govt bonds) on the other hand never have this problem. They're the most liquid and efficient security market in the world.
Inflation increase: If inflation increases and you're stuck with a bond that has a fixed rate, then you're SOL. Your real rate of return is how much interest you receive above inflation. When inflation increases then your real rate of return goes down.
Reinvestment: You could say this encompasses all of the above. As you receive dividends and you need to reinvest them all of the above could penalize you. Especially if the bond is called (paid off) early.
If you're looking for a great book on bonds, I'd suggest: Bonds: The Unbeaten Path to Security.
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