Bond prices change with interest rates – when rates go up like they’re doing now, bond prices go down. This is because investors prefer to get paid higher rates, and if old bonds offer lower rates they will trade at discounts. The longer before the bonds mature, the bigger this discount. Since rates are clearly going up and probably will for many years, this is the single biggest risk facing bond investors today.
Unlike stocks, fair bond prices are hard to determine. Municipal and corporate bonds don’t trade much, and are generally only worth what a dealer is willing to pay. You generally can’t look up a bond’s price in the paper, and need to rely on your broker’s estimate of value, which can often be inaccurate for various reasons. And remember dealers have to resell to other investors at a profit, so the price they pay a seller is less (sometimes much less) than the price they will charge a buyer, which is often much higher than their own “wholesale” cost.
There is a very clear trend that interest rates are increasing in the US. This means bonds you own or may buy will almost certainly go down in value. If you hold to maturity, you will get lower than market interest, so the loss won’t be avoided. We don’t think this is a good time to hold or buy bonds, and suggest you avoid them. The longer you wait, the more we believe you will get burned.
Not all bonds are safe bets. US Treasure bonds are considered riskless in terms of default, but will still go down with interest rate increases. The same is not true for municipal or corporate bonds, which have risk of default – basically getting stiffed and not getting your investment back when the bond matures. While ratings are important to assess this risk, conditions and ratings change over time, and even bonds rated high now may not stay so. When the next recession comes, some bonds may become worthless. High yield bonds (they use to call high yield bonds junk bonds for good reason) are at the greatest risk of this. If you have or are considering bonds, get a free Bond Stress Test to help understand risks and costs. Your Personal Wealth Advisor.
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