Bond Price Fluctuations
There are two primary factors that affect bond prices — interest rate changes and credit rating changes. Interest rate changes typically will cause a bond’s value to fluctuate more than credit rating changes. As interest rates rise, a bond’s price adjusts down, while the bond’s price will increase when rates decrease. Simply put, bond prices and interest rates move in the opposite direction. Also, bonds with longer maturity dates are more vulnerable to interest rate changes, since the difference will impact the bond for a longer time period. Credit ratings also influence a bond’s price. When a bond is issued, rating agencies assign a rating to give investors an indication of the bond’s investment quality and relative risk of default. Typically, higher-rated bonds pay a lower interest rate than lower-rated bonds. After the bond is issued, the rating agencies continue to monitor it, making changes if warranted. A bond’s price tends to decline when a rating is downgraded and increase when a rating is upgraded. The price change brings the bond’s yield in line with other similarly rated bonds. However, these price changes are typically minor if the rating changes by only one notch. Certain downgrades are more significant, such as a downgrade that moves a bond from an investment-grade to a speculative rating, a downgrade of more than one notch, and a series of downgrades over a short period of time. In those situations, you should review whether you want to continue to hold the bond. If you want to minimize the risk of price fluctuations, consider these tips:
If you hold a bond to maturity, you receive the full principal value, so you won’t be affected by any price fluctuations.
Consider investing in bonds with shorter-term maturities, which are less susceptible to interest rate changes.
Design your bond portfolio using a ladder, so you’ll have bonds coming due every year or so. This strategy typically lessens the effects of interest rate changes. Since the bonds are held to maturity, changing interest rates won’t result in a gain or loss from a sale. Bonds are maturing every year or two, so your principal is reinvested over a period of time instead of in one lump sum. If interest rates rise, you have principal coming due every year or so to reinvest at higher rates. In a declining interest rate environment, you have some funds in longer-term bonds with higher interest rates. A bond ladder keeps your bond portfolio invested in a range of maturity dates.
Choose bonds that match your risk tolerance. Safer bonds, such as U.S. Treasury bonds or investment-grade corporate bonds, are less susceptible to credit rating risks.
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This newsletter was prepared by Integrated Concepts Group, Inc. The opinions expressed in this newsletter are for general information only and are not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. The views expressed are those of the author and may not necessarily reflect those held by PlanMember Securities Corporation. Material presented is believed to be from a reliable sources and PSEC makes no representation as to it accuracy or completeness.