By now, nearly everyone knows that some sort of investing strategy is necessary if you want to be a successful investor. However, before you can formulate your investing strategy, you need to get a little information. Today we will have a look at bonds. Investing in bonds can be interesting because they often appear to “gain” or “decline” contrary to what one would think intuitively. One way to gain a better understanding of bond investments is to learn the connection to bond movements and interest rates.
Relationship between bonds and interest rates
Bond yields are directly affected by interest rates. This is because a bond is basically an IOU from the government or a company. It is debt, and so gains interest. You pay for bond, and are basically lending money to the organization. You are promised payment back with interest. The interest rate depends on how long your bond is for (higher rate for longer terms) and also the financial strength of the organization (riskier organizations offer higher rates to attract investors).
Here’s how interest rates affect bond prices:
When interest rates go up, bond prices go down. This is because the bonds that are already “out there” are not competitive anymore because current rates are higher. However, when interest rates fall, the bonds already issued are at higher rates, making bonds more valuable.
Investing in bonds
When it comes to investing in bonds, there is an investing strategy that can be used. The best time to buy short-term bonds (with maturities ranging from six months to one year) is when interest rates are low, with the likelihood that they will rise soon. If interest rates are on the way up, intermediate bonds (5 to 10 years) are a better choice. There are also bond funds that invest in such securities. These are usually divided into short-term bond funds and intermediate-term bond funds.
Another investing strategy for use with bonds is selling your bond before it matures. This is where some investors attempt to make a bigger profit. If interest rates are lower than your bond rate, you will generally make a profit on this move. Of course, if your bond rate is lower than the present interest rates, your early bond decision will result in a loss.
As always, with formulating an investing strategy, it is important to remember that you could very well lose money. There is risk inherent in all investments, and no advice is immune from resulting in losses.
For more information on investing in bonds, The Motley Fool offers a good primer.