Bond Investment Risks

by Lana Walton | May 7, 2018 1:11 pm

Bonds are very crucial when it comes to any investment portfolio. This is because they can provide stability via HQBroker Reviews[1] the principle and regular interest payments.

However, risks still come into play. Like many other investments, these risks are inherent. They cannot be removed. However, they can still be offset by knowing what they are and how they affect your portfolio’s profitability.

Here are the risks associated with the fixed-income market.

Risk number 1: Interest Rate Risks

Nowadays, bonds are a concern for those who don’t have a clear idea about bonds’ relationship to  Forex Bonus [2] interest rates.

Simply put, bond prices and interest rates are inversely correlated. That means when interest rates rise, bond prices fall. When interest rates fall, bond prices increase. If you’re not yet familiar with this, bear in mind that individual bonds should be held to maturity during a time when interest rates are rising.

If you plan to buy bonds, you should also be familiar with duration, which is the sensitivity of a bond or bond portfolio towards interest rates. If the duration is low, the sensitivity is also low. In general, bonds that have shorter maturity also have lower sensitivity to interest rates. Meanwhile, bonds with longer maturity tend to have higher duration. They are more affected by the fluctuation of interest rates.

Risk number 2: the Quality of Credit

Each kind of bond sport a credit rating that has something to do with the financial strength of the bond issuer.

Bonds that reach investment grade have higher quality. This makes them more stable. Meanwhile, other bonds that fall below investment grade are also known as junks bonds, which are lower in quality. To make investors buy them, junk bonds give a higher interest payment for the risk of investing in their lower quality.

If the issuer misses an interest payment, the credit rating will fall down. This, in turn, will also decrease the value of the bond price.

Risk number 3: Inflation and Taxes

If you have a high percentage in your portfolio allocated in bonds, you might not be able to catch up with inflation.

Bonds can minimize the volatility in portfolios, but they will less returns compared with stocks in the longer-term. The interest payments in bonds do not increase along with inflation. If you want to keep up with the speed of inflation, it’s advisable to allocate some of your portfolio percentage to stocks.

The taxes that you have to shoulder are also important to consider. Municipal bond interest, in the United States, is tax free on the state and federal level. On the flip side, for them to be tax-free, the bond needs to be issued from the same state where you come from. If that cannot be done, it will be taxed on the state level. Meanwhile, even if they are tax-free, capital gains will still be taxed. If you buy or sell a bond for profit, it will be taxed as a capital gain.

 

Endnotes:
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  2. Forex Bonus : http://allforexbonus.com/forex-broker-reviews/hqbroker-review

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