Thursday, December 02, 2004
Investing in Fixed Income:Bonds www.legacyannuities.com
Potential Danger When Interest Rates Are Low
If you own bonds or bond funds, you know by now that the prices of fixed income securities move inversely with interest rates. Therefore, it seems that the best time to buy bonds or bond funds is when interest rates are high. Not only do you lock in a high rate, if interest rates subsequently declines, fixed income securities appreciate.
Correspondingly, the worst time to own or buy fixed income securities is when interest rates are low. You get a low rate locked in and if interest rates subsequently rise, you will suffer a decline in value. What solutions are there for fixed income investors?
If you buy individual bonds and hold them to maturity, then fluctuations in interest do not matter, as you will receive the face value of the bond at maturity. Fluctuations are a concern only if you sell bonds prior to maturity and must accept market value. Bond funds however do not have a maturity date so there is no date when you have assurance of recouping your original principal (it will be higher or lower than your original investment). Additionally, many bond fund investors do not realize that there is a trade off in bond funds. Funds that pay lower dividends have higher price stability and vice versa.
Therefore, you should check that your fund managers actively change the term of the bonds in the portfolio, if these price fluctuations are a concern to you. By switching to sorter term bonds during periods of low rates, subsequent fluctuation in the fund share value will be minimized. However, such a fund that acts to protect your principal will need to cut the fund dividend because short-term bonds pay less interest. Some investors flock to funds with the highest dividends (usually payable by investing in longer-term, higher interest bonds), and they soon learn that funds with long-term securities will fluctuate more in value.
Potential Danger When Interest Rates Are Low
If you own bonds or bond funds, you know by now that the prices of fixed income securities move inversely with interest rates. Therefore, it seems that the best time to buy bonds or bond funds is when interest rates are high. Not only do you lock in a high rate, if interest rates subsequently declines, fixed income securities appreciate.
Correspondingly, the worst time to own or buy fixed income securities is when interest rates are low. You get a low rate locked in and if interest rates subsequently rise, you will suffer a decline in value. What solutions are there for fixed income investors?
If you buy individual bonds and hold them to maturity, then fluctuations in interest do not matter, as you will receive the face value of the bond at maturity. Fluctuations are a concern only if you sell bonds prior to maturity and must accept market value. Bond funds however do not have a maturity date so there is no date when you have assurance of recouping your original principal (it will be higher or lower than your original investment). Additionally, many bond fund investors do not realize that there is a trade off in bond funds. Funds that pay lower dividends have higher price stability and vice versa.
Therefore, you should check that your fund managers actively change the term of the bonds in the portfolio, if these price fluctuations are a concern to you. By switching to sorter term bonds during periods of low rates, subsequent fluctuation in the fund share value will be minimized. However, such a fund that acts to protect your principal will need to cut the fund dividend because short-term bonds pay less interest. Some investors flock to funds with the highest dividends (usually payable by investing in longer-term, higher interest bonds), and they soon learn that funds with long-term securities will fluctuate more in value.
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