How to Control Risk in Your Bond Portfolio
Many are worried about interest rates going up and bonds losing value. The good news about bonds – you have the ability to control risk in your bond portfolio, better than with your stocks. The reason being – bonds have a “Maturity Date.” This is something you don’t have with your stocks.
When stock is purchased and the market moves against you, value is lost and you’re left with no idea if and when the market will rebound along with you recouping your losses.
If you own a bond, a maturity date is associated with it. On a predetermined date in the future the corporation that issued it, will pay your principal and interest back regardless of what the bond is worth on the open market. If interest rates go up and the value of the bond is worth less on the open market, the bond is safe, because it doesn’t have to be sold. A bond can be kept until the maturity date and get all money back, plus the interest promised by the corporation who issued it. If you own the bonds directly, you have the choice of whether or not you want to sell it on the open market or keep until maturity.
With “Bond Funds,” you don’t have this option. When you’re in a bond fund, the advantage of having a maturity date is lost. Since you are lumped in with other investors, if someone decides to pull out, the manager may be forced to sell bond positions, in order to cover the out-flows. He must sell the bonds before maturity. You lose, because others are pulling out. You can prevent this by owning your own bonds.
Don’t be afraid to own bonds as a diversification tool in your portfolio. Make sure to consult with the right investment advisor that can show you the proper strategies to control risk in your bond portfolio.
Disclaimer: Any fixed income security sold or redeemed prior to maturity may be subject to loss. In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and as bond prices rise, interest rates usually fall. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk and credit and default risks for both issuers and counter-parties.