josh,
Companies will go to great lengths to pay their bondholders their interest and principal back. Companies are rated by credit agencies such as Moody’s. If they default on a bond, their rating goes down. This makes it much more expensive for them to get credit (just like a bad Fico score does for a consumer). They would have to pay higher interest to prospective bondholders in order to attract bond investors.

If the company were to go bankrupt, the bondholders are first in line to get paid back - ahead of the stockholders. This is the fundamental reason why stocks are riskier than bonds, and why stocks have superior returns (to compensate for the added risk).

I think one question is…why were sub-primes allowed in the first place. Some said it would not work and some of the games played by the lenders were proven true. Legal/illegal practices were done. Some CEO’s made millions and the companys went down. They didn’t know what was wrong? How about some jail time, look what this did to the economy. Greed did it. Isn’t it about time people should make sure the politicians did something about this. Remember Washington runs on greased palmss, but YOU put them in office.

I agree that mortgage companies that broke the law should be punished. But in many cases, they did nothing illegal and the borrower simply did not read or understand their loan terms. Now those people want someone to bail them out. That makes no sense. If you can’t afford a home, don’t buy one. Make sure you know what you are getting into. And if “predatory” lending practices are legal, write to your congressman to change the law. In many cases, the mortgage companies have already paid for making bad loans to people that shouldn’t own a home. Take a look at CFC and IMB for a few that are still in business.

i-bonds are a great way to go right now. Better yet, set them up in Roth IRA for the year.

$20000 down to $8000? What the hell did you buy?

As W.C. Fields famously said “You can’t cheat an honest man”

To Eric,

What about all the predatory lending practices of the mortgage companies? Maybe we should go after all of those animals and arrest and fine them so they lose everything too.

“EXCESSIVE” MATURITIES

Well-rated bonds still offer a balance for the portfolio risks of stocks. They always will. That said, they clearly do not offer the same award potential of stocks and stock funds. They never will. That is not their purpose.

The worst mistakes people make, when considering bonds is:

1. Buying too large a percentage of them when you are a young investor

2. Buying too long a maturity when interest rates are historically low, which they are now

The best time to buy bonds (in their history) was during the Carter Administration, when interest rates were double digit. Then, you wanted the LONGEST maturity date you could get.

Not so now.

sanjosemike

I bought an individual Alabama Power bond many years ago in a falling interest rate environment and did quite well on it. Recently-I bought a long term bond fund as soon as the fed started dropping their rates-specific results so far:purchase price-$11.33, current price $11.44-about a 1.23% boost in the yield-hardly the 8% price change this article predicts-so I think you get better results with individual bonds. As for timing-I have yet to see a time when the fed has starting cutting or raising rates that they only make one cut or raise-I jump as soon as they turn the corner…

One thing I don’t understand is how does a company decide when to not pay the bond back. Is it on a whim, or do bonds have priority to dividends on their stock? Can the company decide they need cash and just default? Can they decide to pay some but not others if they are all the same level of seniority? I’ve looked everywhere on the web for this.

Some previous commenters state that there’s no price risk if one holds one’s bonds to maturity. In reality, this practice would only reveal that what we here are calling “price risk” is actually just the marking-to-market of opportunity cost. In essence, by holding the bond to maturity when more attractive bonds were available, you locked in your price risk and it became accountable for as your oppportunity cost - the difference between what you were repaid, and what you could have been repaid in the higher-interest-rate vehicle.

I’m have to agree with the author on that one. I have one of the best bond geniuses in the world working for me full time watching bond prices daily and investing for me. Big shot? no, I stuck a couple grand in a PIMCO bond fund.

For a bond fund, if you buy it and hold on to it for a “long” time (let’s say -15-20 yrs) and collect the yield as income do you have to worry about the fluctuations in NAV w/changes in interest rates. Would this be similar to buying a bond and holding it to maturity? Thanks.

One thing the article does not mention is the wide spreads bonds seem to have (maybe not treasuries). If you change your mind and what to sell what you bought, even if interest rates held or moved a little in your favor, you will loose because you buy near the ask price and sell near the bid price. And the bid/ask spread you get at your broker will probably be wider than what he really sees. It’s basically a hidden commission and it can be large. I think I read total spreads of 2-3% are not uncommon. Perhaps others can correct or clarify.

i think all govt bonds are nice instruments for business engage in currencies exchanges ……hedging and all that stuff……any comments…..

John…what kind of bond do you have? Interest rates are at historic lows and treasuries have been great investments, with fantastic capital gains. Sounds like you have some structured cra*. You need a fair amount of capital to trade cash bonds..and you should have an idea where the price should be…if not…look out cuz your gonna get a haircut. Munis are the absolute worst for haircuts (more like getting scalped). Most bonds are buy and hold investments because of the bro. Trading callable agencies is a real popular strategy…but you need to do a little homework. Trading bond or note futures is the cheapest way…but you need about 25k in a margin account. You can trade a 20 year equivalent with small amounts like a stock (Lehmans IShares TLT)…it’s a great way to box out greedy brokers. You can also trade small amounts of bonds online at a fairly reasonable prices through Fidelity or Etrade. They post the book for you to view…but it’s all sell side dealers. Still better than calling a voice broker. Also look at preferreds right now…some great deals and they trade like stocks. Good luck all.

I always love reading the opinion of people that are not advisors themselves. Bottom line is this - for some people, bond funds are a good idea, for others, indvidual bonds make sense. It depends on a number of factors.

It’s neither fair nor sensible to to say one is “better than the other”. I wonder if some of these posters have hidden agendas. Or maybe they just work in a call center at Vanguard.

In any event, most investors should hold bonds to reduce risk and to generate income.

For others, if they are savvy, they can be a way to generate gains as well (such as international bond investing or purchasing a TIPs fund or issue over the past 2 years).

Bonds offer three things that funds can’t. 1- maturity date, 2- fixed rate of return, 3- maturity value. You buy bonds for income, hold them to maturity, and you don’t lose. But when your investment in a bond fund drops 20-30% when do you get your principal back? Problem is….. many times you never do.

Bait and switch. I assumed by the title of the article that I was going to get some insight into the timing of buying bonds now, in today’s environment. I did not expect a Bond 101 lesson with absolutely no commentary on the market.

In regards to Mike’s comment about falling rates. The short term rate has been dropping, but the long term rate (10 year +) is going up.

I feel like this article is more of an opportunity for Walter Updegrave to bash individual bonds than to answer the question. The truth is that individual bond investing is perfectly suitable for individuals of many income levels. While bond funds may be more appropriate for individuals more than 10 years from retirement that simply want something with a negative correlation to their stock portfolio, individual bond investing is a great tool for retirees and those looking at specific time frames and goals. As opposed to bringing up these and other points, the article simply comes off as unobjective by projecting an unfavorable light upon the product.

If John Stuart’s bond was issued by a financially healthy entity, then it probably would not have dropped in value from $20,000 to $8,000 in just a couple of years.

I agree. Bonds are typically bought for income (not cap gains), and when you buy them, you should generally be prepared to hold them until maturity.

In response to John Stuart: There are risks involved in any investment. Why should the government be responsible for bailing you out of a decision you made yourself? If you are not willing to accept the risks of an investment, put the cash under your mattress. This should apply to housing as well. The government does not have a responsibility to protect people from buying a house they cannot afford. Independence and self-reliance used to be cornerstones of the American psyche. It’s time to bring those traits back.

You did not mention the largest bond risk for long-term bonds, namely, the inflation risk. The $10,000 you are repaid at maturity for the S10,000 bond will not be as valuable as the $10,000 you invested at the start. The interest payments may, or may not, compensation for the loss of purchasing power.

You didn’t mention the other bond risk - inflation risk. If inflation is 5% during the term of a bond then when you get your face value back it’s reduced in value by inflation or 5%. If you sell before it’s term is up you will get back less because the buyer is taking on this inflation risk.

I’d just invest in the Vanguard Total Bond Market Index and forget about it.

To John Stuart,

Assuming your bonds were Govt issued, then the Govt will bail you out by paying you back the full $20,000 you invested. All you have to do is wait until they mature. Sheesh!

Why do some people expect the Govt to bail them out of every bad personal decision they make?

I wanted to clarify John Stuart’s comment. He says his wifes bond has fallen from 20,000 to 8,000 in value. I image that is the current value of the bond if sold “today”. However, if the bond was held to maturity wouldn’t you get your 20,000 back? or does this bond involve CMO isseues. If your bond was issued by a financially healthly org. orgovt. entity, you get all your $ back. This is still the case w/ munis.. So maybe the lesson is , if you can’t wait until maturity, don’t buy

You need a lot more than $50k to invest in individual bonds. Assuming that you would want at least 20 different issues for diversification, that would be only $2,500 per bond, which is not a large enough lot to be profitable after commissions. Most institutional investors buy in lots of at least $1MM. Individual investors should look at bond funds - I currently like long-dated high quality munis.

You should have pointed out that if a bond is held to maturity and is repaid, then is no price risk for the holder.

Duhh. Maybe I’m a investment novice but the investment article seems to dwell on what happens when to bond value went interest rate rise. Well for the passt 6-months or so, interest rates have fallen. Is this not good for bond investers?

Fred, you are a bit off topic, but it is going to the banks and financial institutions, to keep their balance sheets from collapsing. The Fed’s key concern right now is to keep those institutions functioning. If they go down, we will all have bigger issues than a mortgage default… they are the oil in the engine of our economy, and if they go bankrupt, the economy crashes, and we could end up with double digit unemployment.

A couple of years ago, my wife and I invested $20,000 in bonds to bring back a safe return and use the money later on for our daughters’ weddings. The bonds are now worth $8000 - it’s still paying interest, but it was the worst investment we have ever made.

If the government is bailing out mortgage lenders and borrowers, who is going to bail out people like us who have lost 60% of our investment?

Where is all this money going that is being injected into the economy, certainly has no effect on residential borrowers,the consumer continues to be sqeezed in this economy….