Conservative investors who buy bonds to avoid high risk might inadvertently be exposing themselves to a potentially devastating risk: interest rate risk.
If you are concerned that you may have interest rate risk or other hidden risks in your investments, call my office at 02-624-2788 to discuss your portfolio.
Are bonds safe?
When you buy a bond, you lock in a specific interest rate that you’ll earn until the bond matures. Assuming the issuer of the bond remains solvent, you’ll receive your interest payments (usually every six months), and on the “maturity date” you’ll get the principal value of the bond. That’s what happens in most cases. But…
When interest rates rise, people who have locked in a lower yield discover that their bonds decrease in value. For example, let’s say you own a $50,000 bond that pays 3%. After you have bought the bond, if rates for similar issues rise, say to 5%, the principal value of your investment drops. It drops, since a 3% return pales in comparison to a 5% yield. If you hold your 3% bond to maturity, you will get your principal paid back, but if you need to sell it beforehand, you will likely lose money. That is interest rate risk – the fear that if you have to sell your bonds before maturity you’ll potentially lose out on regaining your full principal.
Longer term bonds and preferred stocks
If the bonds you own will reach maturity relatively soon, the rise in interest rates will have a limited effect on their price. But longer term bonds and preferred stocks (which often act like long-term bonds) can drop in value significantly if interest rates rise. For more information about investing in bonds, click here.
If you own bonds and would like to discuss the risks, please call (02-624-2788). If you see yourself as a conservative investor but worry that you might be exposed to interest rate risk, be in touch right away.
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published November 22, 2016.