“Are bonds safe?” asked a fellow in a café who recognized me from the Friday paper. He then looked down and lamented having to pay NIS 22 instead of NIS 14 for his coffee. “Inflation,” I commented. Then he asked for advice about bonds: “If the central bank raises interest rates to control inflation (rising prices), bond values could fall, so should I sell the bonds in my retirement portfolio now?”
I told him that it’s nearly impossible to predict what the Fed will do, but I did suggest three things he should understand when buying bonds.
Credit risk
When you buy a bond, you lend money to a government or a company. In exchange, they pay you interest for the time they hold the funds. U.S. government bonds are considered to be among the most creditworthy bonds, which is why global investors often buy Treasuries in times of financial crisis. Corporate bonds normally have a higher chance of default than Treasuries, but they also pay a higher interest rate. Many people also like to buy Certificates of Deposit in a bank, which are FDIC insured (find out more at Profile-Financial.com/cd).
Interest rate risk
When you buy a bond, you lock in a specific yield. If interest rates then rise, you’re still holding on to a bond that has a lower rate. Your bond will be less attractive in the marketplace and will go down in value. Of course, the opposite is true. If rates drop, the value of bonds your already own should increase.
Inflation risk
What happens in the real market, such as in your coffee shop, is often the best evidence of whether economic growth is picking up. The reason that inflation causes the prices of bonds to decrease is because people know that when those bonds mature, the future value of the dollars won’t buy as many goods and services as they do today. If the money will be worth less in the future, the bond will also go down in value today.
Diversification can decrease risk
Regardless of these risks, bonds as part of a diversified portfolio offer the benefit of spreading out risk. To see if they might be a good investment for you, watch a video on bonds and bond funds here: Profile-Financial.com/bonds
Douglas Goldstein, CFP®, GFP®, is the director of Profile Investment Services, Ltd. www.profile-financial.com. He is a licensed financial professional both in the U.S. and Israel. Call (02) 624-2788 for a consultation on how to set up your American assets to meet your financial goals. Securities offered through Portfolio Resources Group, Inc. Member FINRA, SIPC, MSRB, FSI. The opinions expressed are those of the author and not those of Portfolio Resources Group, Inc. or its affiliates. Neither PRG nor its affiliates give tax or legal advice.
Published February 26, 2018. Updated December 2022