The market is difficult to predict, so investors try to play safe by ProfitiX Broker investing in bonds. However, there are times when we experience negative bond returns. There are risks to that, and there are also ways to avoid them.
Read this article and protect yourself from negative bond risks.
The Main Risks
To avoid the risks of having negative bond returns, you must be familiar with the main risk factors that can affect bond prices.
The first thing you have to be careful of is interest rates.
When interest rates rise, bond prices usually fall. This is because investors can invest in new bonds that have similar features that whip out higher bond coupon rates.
In order to equalize the existing market coupon rate, the existing bonds need to be cheaper.
If an existing bond receives downgrade in terms of its Profitix Broker Review credit rating, it becomes less appealing to investors.
They will also require a higher interest rate to invest and that, again, takes place with the lowering of the bond price.
Liquidity risk is affected by investor supply and demand.
You can tell that there’s low liquidity if you see that the bid-ask spread is widening, which means that there is a larger price difference between an investor that buys a bond from the one that sells.
Call risks exist if a company is allowed to call in a bond and issue a new one. This usually takes place in a period of declining interest rates.
There’s also the reinvestment risk, which happens during rising interest rate periods, during which an investor has to reinvest a bond that has already matured.
Holding Individual Bond Positions
The very basic way to avoid losses in your bond portfolio in times of rising interest rates is to buy individual bonds and wait until they mature.
With this strategy, you can reasonably rest assured that you will receive your principal back at maturity, and this gets rid of interest rate risks.
The present bond price may fall down when the rates rise, but you can still receive your original investment back at the defined maturity date of the bond.
You can also get rid of the credit risks, particularly for bonds with stronger credit ratings since there is minimal risk that the underlying company becomes insolvent.
You can also be safe from liquidity risks since there is no need to trade the asset.
When interest rates are falling, the one risk that you can’t eliminate would be reinvestment risk since the funds that you get at maturity will be reinvested at a lower coupon rate.
During interest rate hikes, or times when rates are predicted to rise in the future, staying invested in the bonds with nearer-term maturity can be important.
Interest rate risks become lower for bonds that have shorter maturities. Bond duration refers to the sensitivity of the bond price to the changes in interest rates.
Bond duration shows that the prices change less for closer maturity dates.
For money market funds with the shortest maturity dates, they adjust immediately to the higher rate and in the vast majority of cases do not experience any loss of principal.
Staying on the shorter end of the maturity dates can help you avoid negative bond returns, and offer a chance to experience a rise in yield during times of higher interest rates.