August 14, 2019
Recent volatility in the stock market has many investors looking for "safety". Many turn to government bonds. But is now the right time to invest in these notes? Today we'll talk about the hidden risk in bonds.
Key Concept 1: Yield
When talking about bonds, the first key concept is yield. Yield is the return you will earn when you buy a bond. It factors in the current price, the interest rate, the date it matures, and the return of principal.
If you buy a bond with a 2% yield and hold it until maturity, that is the return you will realize.
Key Concept 2: The Relationship Between Yield and Price.
The second concept is the relationship between yield and price. Bond yields and bond prices are inversely related. This means when bond prices go up, yields go down. And when yields go up, prices go down.
Where is the Hidden Risk In Bonds?
Bond yields are near historic lows. And it is hard to imagine them going lower. When they increase, it could create a very difficult situation.
Those who buy these longer term notes will face two choices. The first is to accept a low rate of return over the next several years. The other option is to see the value of their investment decline as yields move higher.
If you would like to see an example of how rising yields impact bond prices, check our post at: