My bank talked me into investing in bonds. The market value of my bonds have been dropping. Should I worry?

Question

Will I get like they claim both my principal and interest at maturity or should I ask for my money now and avoid more losses later?

Answer 1

The market value of a bond will fluctuate depending on the changes in interest rates. If you hold the bond until maturity, you will still get your principal back, as was stated in the bond's contract.

Here are some exerpts from my book:

"Before I go much further, I want to make sure you understand what total returns are. I am not just talking about the interest, or coupon, payments from bonds. That is one source of returns. There are actually two more. Secondly, interest can be reinvested to purchase more bonds which pay more interest. This is called compounding, or interest-on-interest. And thirdly, you can incur a capital gain or loss if you purchased your bond for a price other than par. For example, a discount bond sold for $900 will be redeemed for $1000 (its par price) on the maturity date, and thus the investor will receive a $100 capital gain as part of the bond's return. When we look at historical data, we are looking at total returns which include all 3 sources of income. " - Page 87

"The first risk we will discuss is interest rate risk. It is the prominent risk inherent to bonds. It exists because bonds traded on the secondary market must compete with newly issued bonds.

As long as the bond's issuer remains stable, the bond gives the investor a guarantee that the issuer will make the interest (or coupon) payments at certain intervals and will then pay back the original sum of money lent (the principle) at a specified date (the maturity date). It is because of this that most investors assume high-quality bonds have no risk.

The problem occurs if you wish to sell your bond before it matures, on the secondary market. If interest rates have risen since you bought your bond, newly issued bonds will be sold with higher coupon payments than what your bond pays. As a result, no other investor will buy your bond at the par price. Why would they? They can, instead, purchase a newly issued bond at par price, but one that pays higher interest. So, in order to make your bond competitive, you would have to sell it at a discount. The discount necessary would be the price at which your old bond yields the same interest to the new investor as the newly issued bonds would. Remember that bonds are only issued and redeemed at par. What happens in between is based on free market forces.

Let me illustrate with an example. Let's say that you bought a 10-year Treasury bond on the day of its issue, at $1000 par. It was issued with a 5% coupon rate, meaning that it pays $50 per year in interest. A year later, you want to buy an Xbox 360. So you decide to sell your bond on the secondary market to get your money back. But the Fed has raised interest rates. Now, 10-year Treasury bonds are being issued with a 7% coupon rate. These new bonds are sold at $1000 par and pay $70 per year in interest. You cannot simply sell your bond at its par price of $1000 because no rational person would buy it from you at that price. They would buy the new bonds instead. In order to sell your bond, you would have to lower its price to around $714. Your bond still pays $50 per year in interest, as is stipulated in the bond's contract. But now, the new owner buys it for $714 and receives $50 per year in interest, which calculates to a 7% interest rate (50 divided by 714 = 0.07), the same as newly-issued Treasuries. (In actuality, the change in price is more complicated that this. I oversimplified to help you understand the basics.)

The actual coupon payment has not changed. Rather, the ratio of that coupon payment to the price has changed. In a secondary market where people can choose to sell their bonds before maturity, prices of outstanding bonds will fluctuate based on prevailing interest rates. This is because current interest rates influence newly-issued bond coupon rates, which compete with outstanding bonds. The outstanding bonds still pay the same coupons and are redeemed at the same par amount on the maturity date, but their selling prices will fluctuate while outstanding." - page 88

"All bonds fluctuate in response to interest rate changes. Even ones with insurance backings and inflation protection. No exceptions. The difference is that long-term bonds (ones with long maturities) fluctuate more widely than short-term bonds in response to interest rate changes. Long bonds tend to have higher coupon payments than short bonds, so there is more to lose if interest rates rise. On the flip side, if interest rates fall, the long bonds have "locked in" their higher coupon payments longer than short bonds, and thus increase in value more than short bonds."

"Now, if I buy my bond at issue and hold it until maturity, I will never have to deal with selling it at a lower or higher price. However, if interest rates increase such that future bonds offer better coupons, I incur an opportunity cost. I am potentially losing money since I could be receiving higher coupon payments with the newer bonds. So do not think that even if you hold your bond till maturity that its value never changes. The coupon and par amount remains the same, but the bond's value fluctuates. In the early 1980s, Treasury bonds were being issued with obscene coupon rates of 15%. The investor who held his old 8% bonds certainly incurred an opportunity cost. Which bond would you rather have in your portfolio?"

A free copy of my book is available for download from my website, in PDF format. Click on my profile and read my info to get the site.

Answer 2

A bonds value is inversely related to interest rate movements. If you think interest rates in the future will be higher than expect the value of your existing bonds to decrease.
However whether you get your original investment back is a different matter... What is the credit rating of the issuer? are they an insured municipal bond or a small cap high yield Dry Cleaner? ...
the issue of whether you should own bonds is a personal one that depends on many things... like what else do you own and what are your goals?...
Ultimately if you are feeling insecure talk to the guy at the bank who sold them to you. Tell him how you feel and get some see if he reassures that they are a good fit...

Answer 3

I would invest in stocks, BUT you have to do your own research. People who don't do their own research deserve to get hammered when the market falls (well, "deserve" is a little too strong of a word). A couple of good pieces of advice: Read the books "Buffetology" by Mary Buffet and "How to Retire Rich" by James O'Shaugnessy. I blend these two philosophies and have been VERY satisfied with the results. Another point, never buy a stock because you heard about it on CNBC or Fox. Those guys are a bunch of mental midgets and they are only there to promote their own PR. Also, NEVER "buy the story." That is don't worry about what contract company X has landed, etc. Finally, diversification is idiotic: it is better to buy a few stocks you KNOW are good rather than a bunch of stuff to hedge your losses. If you don't want to do all that homework (it's really not very much), buy Berkshire Hathaway stock. They never pay dividends so you won't ever have to pay taxes until you sell it way down the road.

Answer 4

It depends on your risk tolerance and the type of bond. Generally, bonds move in the opposite direction to stocks - so in a bull market (which we are in right now) bonds tend to move lower, while stocks move up. In a bear market, bonds move up while bonds move down. However, both stocks and bonds have independent cycles; and at some points, both can move in the same direction.

If you are under 50, you probably shouldn't be in bonds. If you have to ensure you make no loss, you should be in a high interest saving account or CDs; if you can tolerate risk, you should be in index funds concentrated in the stock market.

Answer 5

A. You weren't talked into anything. You bought the bonds.
B. Market values of bonds always decrease as interest rates rise.
C. Never (ever) invest in anything without understanding it fully.
D. Banks and insurance companies are my least favorite companies to go for "investments".
E. Never (ever) invest in anything without understanding it fully. (repeated to further push the idea that you made an investment decision with little to no understanding).

Ultimately you are responsible for your financial health.

Answer 6

It depends on what kind of bonds they are. The market always goes up and down. If you have no faith in the bonds, then sell them now and cut your loses. If you think there might be a chance they will go up, then now is a great time to buy more.

Answer 7

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