Bonds can be used to earn higher interest. However, if you do decide to invest in bonds it is at your own risk. Bond funds that are best for credit risk and offer income tax-free interest are some of the most secure. None insure you against investor losses. When interest rates rise, losses are almost guaranteed.
Municipal bond funds are some of the most popular bond funds. They are exempt from federal income tax and can earn interest on securities within the portfolio. This is the good news. It gets even better. These funds can be used to insure investors against default on bonds held in their portfolio. Then there is the negative news known as interest rate risk. This applies to all municipal, corporate, government, and mutual bond investments, as well as all mutual funds that invest in them.
FDIC may insure you against losses in your bank savings account. The federal government will also tell you that savings bonds can be safe investments. However, this is not the case when you choose to invest in bonds. Even the U.S. Treasury bond, which is the most secure long-term debt security anywhere in the world, does not provide the same protection. All marketable securities, called BONDS, have risks associated to their ownership.
Even the most well-respected bond funds do not guarantee investors protection against rising interest rates. Every bond fund in America warns potential investors about potential losses. Each one of them has it written for everyone to see in the prospectus or other investor material.
Truth is, after 35 years of investing, and as many years as I have spent communicating with average investors, one thing has been clear to me. Many people don’t know the risks involved in bond investing. Let me help you save thousands of dollars in the future by explaining it to you clearly.
Because interest rates are historically low, investors large and small are interested in bond investing. Bonds of all types are attractive because people want to earn more interest. Imagine a piece paper promising to pay you 5% per year for the next 20 or so years. You get $50 per year in interest for a $1000 investment and your $1000 back when the paper matures in 20 years. This is a bond and the $50 figure doesn’t change.
Imagine the price of that same piece paper if it were to continue to exist at 10% interest and $100 per year. Consider how miserable you’d be if you earned half the interest from a new bond issue. Even the casual observer can see the future direction of interest rates with interest rates at an all-time low.
Math doesn’t have to be complicated or difficult. You might get a buyer for your paper but it won’t be worth $1000 unless it matures. As long as the interest rates are higher than your paper promises, it will be held by someone else.
It doesn’t really matter if you have a bond fund or an individual issue. These debt securities lose their value as income-producing investments because they are less attractive when interest rates rise. The hardest hit are bond funds that invest on long-term issues. It’s a good time to invest in bonds when interest rates rise and then fall. While you earn a handsome income, your investment value goes up.