Are Bonds a Risky Investment?
Bonds offered by various companies are often a part of a balanced portfolio and they can provide a good degree of stability to it. Corporate bonds make up the largest form of bond types and there are different kinds that you can buy. Special care needs to be given, though, if you are going to buy them safely because there are some risks attached. By understanding what the risks are, you will be able to reduce those risks and get much better returns.
The Default Risk
This occurs when you buy bonds in a company and it is not able to produce the expected or predicted profit that it needs to pay back the money from them. When this happens, the company is in default for its bond program. You can greatly reduce the risk from default by investigating the financial rating of the company with organizations such as Standard & Poor's.
In some cases the assets of a corporation are tied to the collateral for the bonds. If this is the case and the company defaults, then the assets will have to be sold and the money will be distributed to those according to priority.
The Risk of a Call Back
Some companies offer corporate bonds that have a call back clause in them. This enables the company to recall them before the maturity date - and pay you the principal and a little more. If a call back option is in the bond features, there are set dates when this can occur. You can eliminate this risk totally by checking to see if it is in the terms of the bond; and if so, then by avoiding them completely.
Corporate bond rates are fixed when you buy them. This means that you will continue to get the same interest rate no matter what happens in the market. If the market rate should increase and you try and resell the bonds, you will find that new bonds having a higher interest rate will often sell before you can sell yours, which also means that you will have to sell yours at a discount. You can reduce this risk by carefully watching the interest rates and buying or selling accordingly.
The Supply Risk
If the company continues to offer a lot of bonds on the market, then this could easily decrease the demand for your corporate issue, simply because market rates may have raised the interest rates. This would create a demand for those with higher interest rates, making it difficult to sell yours with lower rates.
The Company's Ratings May Change
The major ratings companies - Moody's, Fitch, and Standard & Poor's - may change the rating of a company's ability to pay. If they lower the rating of a company, then this could definitely lower the value of your investment. This can be caused by many factors, but it does not necessarily mean that you should sell at a lower price. It is possible that the lower rating could be temporary due to some extenuating circumstance, and then the value may return or go even higher. You will have to make this decision and determine whether to try and sell or not.
The Risk of Changes in Taxes
The way that taxes change from time to time can make having bonds a risky proposition. Some tax changes could affect a bond's value and this could happen quickly when new tax laws are passed. The only way to avoid this risk is to keep an eye on proposed tax laws that might affect your bonds, and sell them if need be.
Increased Risk with High-Yield
Corporate bonds that are referred to as high-yield are a greater risk than those that are investment grade. High-yield bonds are usually offered by companies that do not yet have a good rating of financial stability or the ability to ensure paying them back.
Investing in corporate bonds is a great way to add stability to your investment portfolio, but it is not for everyone. There is a much greater risk with this type when compared to either government or municipal bonds. Investigating a company and the bonds available, as well as their features, can help you get safer investments.
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