You Should Invest In Bonds

Category: Finance.

If you are new to investing perhaps you are not familiar with bonds.

Most people assume that all interest- bearing securities are completely risk free, but this is not the case. Before you get started, you need to understand some of the risks associated with bond investing. Even if you know a lot about investing, you may not be aware of some of the risk characteristics associated with bonds. The Federal Reserve( also known as the Fed) meets every 6- 8 weeks to evaluate the health of the economy. The most important thing to take into account is the interest rate. At each meeting, the Fed renders a decision regarding interest rates.

If inflation is moderate or contained, the Fed will likely leave rates unchanged. If inflation is rising, the Fed will need to raise interest rates to tighten the money supply. However, if the economy is slowing down and there is very little inflation or maybe even deflation, then the Fed might decide to reduce interest rates to create a stimulus for economic growth. If you are able to hold your bond until maturity, then interest rate movements do not really matter, because you will redeem the principal upon redemption. The reason why you need to consider present and future interest rate levels is because as interest rates increase, bond prices go down, and vice versa. But often, investors have to cash out their bonds well before the maturity date.

You should also be aware of the claim status of the bond you are buying. If interest rates have moved up since you purchased the bond, and you sell it prior to maturity, then the bond will be worth less than your initial investment. Claim status refers to your ability to liquidate your investment in the event the bond issuer goes bankrupt. If you are buying a corporate bond, there is always, however a chance that the issuer could go out of business. If you are buying a government bond, such as a Treasury Bill, claim status is irrelevant, because the odds of the Federal Government going bankrupt are slim and none. In the event of liquidation, bondholders are given priority over stockholders.

Senior note holders can often claim against certain kinds of physical collateral in the event of bankruptcy, such as equipment( computers, etc, machines. ). However, there are often different classes of bondholders. Regular bondholders can not always claim against physically collateral, and are next in line after the senior note holders. The coupon rate, and the call, the maturity date provisions. Next, you should always check the three main features of the bond you are buying. The coupon rate is the interest rate.

The maturity date is the date that the bond will be redeemed by the issuer. Most bonds pay an interest rate semiannually or annually. Simply put, the maturity date is when the company must pay back to you the principal you loaned to them. Some bonds are non- callable, while others are callable, meaning that the company can buy your bond back before maturity, usually at a higher price than what you paid. The call provisions are the rights of the issuer to buy back your bond prior to maturity. Finally, you should also understand that if economic conditions become more favorable after you a buy a bond, and interest rates start to go down again, the issuer will likely issue a lot more bonds to take advantage of the low interest rates, and will use the proceeds to try to buy back any callable bonds it issued previously. You should invest in bonds.

So, when interest rates go down, there is an increasing likelihood that your bond will be redeemed prior to maturity, if in fact the bond is callable. However, you should also take into account the risk factors we have covered. Talk to your broker about diversifying the kinds of bonds in your portfolio and you will reduce your overall risk and maximize your return. Your portfolio should contain a mix of corporate, municipal, federal, and even junk bonds( there is always a default risk associated with junk bonds, but they pay a huge interest rate) .

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