February 9, 2015

Maturities matter when it comes to owning bonds. Quality and term matter a great deal. Why?

3 thoughts on “February 9, 2015”

  1. Mike Dunlop says:

    Quality and term matters when buying bonds to offset the risks to investors. The quality of the bond is used to determine the level of business risk and the term of the bond determines the interest rate risk.

    When looking at bond quality it is important to understand the rating method. Several companies, such as Moody’s and Standard and Poor’s, rate the quality of bonds. Usually you will see rating such as AAA or BAA. Understanding these levels will help to distinguish high quality bonds (those that will likely pay out til maturity) and low quality or junk bonds (those that have a high risk of failure or insolvency).

    Choosing a bond with a long maturity increases your risk in a couple of ways. First, The longer the term of the bond, the more susceptible the investor is to the company becoming insolvent and not capable of repaying its debt. Second, longer maturities lock the investor into an interest rate that may not be competitive with current interest rates. Choosing shorter term bonds will reduce these two risks.

  2. Garrett Haag says:

    The maturity of a bond affect what they bond is for the most part and how it acts. A short term bond will have a lower yield that does not change very much and is not affected by changes in interest rates as much. A medium term bond has a better yield and does get affected by interest rates more. Long term bonds are the most affected by interest rates and risk and reward is no longer there for them due to this, they have the same risk as stocks without the return of stocks. Quality of bonds also affects what the yield is, junk bonds may say they have a higher yield but they can crash very easy if the markets have a turn for the worse. You should avoid these bonds. On the other hand US treasury bonds have the lowest yield but have the safest return. You should own an index fund that has a good mix of high quality bonds. If you own junk bonds you are better off owning stocks for the risk. You should know this before investing in your bonds so you know what will make them change or go up in down in value. The country of origin also has an effect on a bond. Bonds have a close tie with a counties well being and if you own government bonds of different countries the economic conditions will affect the yield and value of those bonds. Bonds outside of the US generally have a higher risk and return due to the more unstable conditions. Many of these may be junk bond but owning a international bond fund should be looked in to that hold high quality foreign bond.

  3. Mike Finley says:

    You gentlemen covered the issue very well. Let’s recap.

    (1) When owning bonds, keep your maturities under 10 years and closer to 5 if possible.

    (2) Avoid high yield bonds (junk bonds). If you want to take more risk, take that risk with stocks, not bonds. This simply means you would allocate more of your money toward stocks.

    (3) Keep this simple and efficient by owning bond index mutual funds at a place like Vanguard. The Total Bond Market Index Fund and the Short-Term Bond Index Fund will work just fine.

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