Understanding the Risks of Bonds

When making decisions about their connection with the transfer of funds, pre-retirees and retirees are typically paying more attention to bonds as an asset class that can help to reduce portfolio volatility and provide a source of income.

While most investors generally invest in bond funds rather than buy bonds outright, the potential risks associated with fixed income varies considerably and is something that investors should at least be familiar with. Understanding these risks can help investors better trade or allocation strategy that is appropriate for their risk tolerance and time horizon.

credit and market risk

In its simplest form, the bonds represent a loan issuers such as corporations, municipalities or government agencies. Bond issuers promise to pay the bondholder a specific amount of interest, usually quarterly or semiannually, and return the full amount of principal at maturity.

Credit risk refers to the possibility that the issuer will default on bond payments before the bond reaches maturity. To help investors make informed decisions, independent companies such as Moody's Investors Service and Standard & Poor's credit quality ratings published for these bonds ¬ sand. poor rating greater upside reward potential. Issuers of lower rated bonds usually reward investors with higher yield potential for accepting a relatively greater risks. As a rule, bonds issued by companies or municipalities with a triple-B rating or higher are called investment grade bonds. Non-investment-grade bonds, with ratings as low as D, sometimes referred to as junk or high-yield bonds because of higher rates to pay to attract investors.

If the investor is not able to hold bonds to maturity - when the full principal is due - market risk comes into play. The investor will lose part of its equity to sell if the price of bonds has fallen from the acquisition. To avoid exposure to market risk, investors should assess ¬ ma of their overall cash flow projections and the fixed costs between the time you intend to purchase bonds and maturity.

of the economy also plays

Role

economic factors such as interest rates and inflation, can also affect bond returns. Fixed income prices tend to fall when interest rates rise, and vice versa. This inverse relationship is called interest rate risk, which may be a concern especially for investors who do not intend to hold to maturity. Exposure to interest rate risk increases with the length of the bond maturity. Issuers generally pay higher yields on long-term bonds than on those with shorter maturities.

Inflation risk is the risk that the revenue produced by bond investments will succeed the current rate of inflation. comparable ¬ relatively low yields of many high-quality bonds such as U.S. government securities are particularly ¬ larly sensitive to the risk of inflation. In an attempt to remedy this situation and encourage more people to increase their savings, the Ministry of Finance in January 1997 began issuing inflation indexed bonds, known as Treasury Inflation Protected Securities, or tips, with a return linked to inflation. The main bond index to consumer price index, an indicator of inflation calculated by the U.S. Department of Labour.
ETFs can be a logical choice

Not everyone has the time or knowledge to manage a portfolio of individual securities. With so many options to choose from, with individual bonds and require the initial

investment ranging from $ 1,000 to more than $ 25,000, many investors opt for a simple bond mutual funds. These funds offer the advantage of instant diversification, professional management and daily liquidity. However, because bond interest is taxable, these funds may cause a taxable event when they are held in non-retirement account. Also, investors should be aware that as the individual bonds themselves, bond funds carry risks. Before investing in a bond fund, be sure you understand your risks and goals.
bond market provides a wealth of fixed income products to suit almost all invest ¬ ment goal and risk level. With all these options, choosing investments that will follow your specific needs are often not easy to support investment and tax professionals is advisable.

This article is not intended to provide specific investment or tax ad ¬ vice for each individual. Consult me, your financial adviser or your tax advisor with questions.