Bonds
Fixed-income securities that pay interest and return principal at maturity.
Bond returns come from more than the coupon
A bond is a contractual claim on an issuer, but its market value can change long before maturity.
Interest rates, credit quality, maturity and the likelihood that the issuer can repay principal all affect the price. A bond with a high coupon can still lose value if rates rise sharply or investors become concerned about the issuer.
That is why yield and credit risk need to be evaluated together.
Maturity changes the risk
Longer-term bonds generally react more to changes in interest rates than shorter-term bonds. Credit-sensitive bonds add another layer: their prices can fall because investors demand more compensation for default risk.
Investors should compare duration, credit quality, yield to maturity, call provisions and diversification rather than judging a bond or bond fund from its stated coupon alone.
Common mistakes
- ×Buying long-duration bonds without accepting the price impact of rising rates
- ×Reaching for yield without examining credit quality
- ×Holding a handful of individual issues and calling it diversified
- ×Ignoring that interest is taxed as ordinary income in a taxable account