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Controlling Bond Trades

Bonds

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One of the most important requirements to long term bond investing success is controlling bond trades. Purchasing bonds shortly before a rise in bond rates will reduce the value of a bond. Purchasing bonds immediately before a decrease in rates will raise the value of a bond. Since you can’t ever control when rates will rise or fall, you can only attempt to preempt the central banks setting the rates of the bonds. Watching economic indicators can hint at rate rises or falls, but surprises have happened before and will happen again.

The effects of interest rates can be partially bypassed by holding the bond to maturity. These changes will not affect the return over the lifetime of the bond, only their sales prices. You can sell bonds trading at a premium or a discount to par value, or hold the bond to receive higher or lower interest that you can receive from the market. At maximum you can lose potential returns you would have earned from selling the bond and reinvesting the profit at higher rates, but the total return must compensate for the discounted sale value.

Interest Rates Fall

When interest rates are lowered, you have several options. You can purchase short term bonds to avoid being locked into long term bonds at low rates. If you own bonds before the rates were lowered, you can sell them above their old value. Bonds issued before the rate change will pay higher yields at the same levels of risk, but they will sell above their prices before the rates were lowered.

Interest Rates Rise

When interest rates are raised, you also have options. You can purchase bonds issued before the rate change at decreased prices, but you will be receiving lower interest rates compared to fresh issues. You can purchase freshly issued long term bonds to lock in long term rates for long periods of time. When the rates are lowered you can sell these bonds at premiums or keep them to receive higher than market rates.

Long Term Bonds

Playing with long term bonds can be problematic. Anytime you invest money you need in individual bonds, you should be concerned about the timing of bond maturities. If you are purchasing bonds with money you need, ensure your bonds mature before you will need that money. For example, if you are sending your kids to college in 6 years, bonds being used to grow tuition money will need to mature in less than 5. Purchasing 10 year bonds would ruin your plan.

Due to the changing interest rates and the reinvestment risks bond investing is never guaranteed to deliver a specific return over the very long term. You can easily be reinvesting income at higher or lower rates over the long term. These issues depend on what happens in the economy and when they occur. You must include potential changes into your approach and strategy.

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