Bonds 101

A bond is a loan issued by an entity such as a government, municipality, or a corporation. Bonds are known as fixed income debt securities. When you purchase a bond, you are loaning money to the issuer. In return, the issuer pays you a specific rate of interest (coupon). You can loan the money for a length of time of your choosing (maturity). Bonds can range in maturity from one week to 30 years. Once you choose a maturity (length) that fits your needs, you will receive interest payments (usually semi-annual) throughout the life of the bond. Upon maturity, you will receive the “face value” of your original investment.

Most investors benefit from a diversified portfolio. A diversified investment portfolio would consist of stocks, bonds, real estate etc. with allocations based upon individual needs and objectives. The role of bonds in a diversified portfolio is to provide a constant stream of income. Most bonds pay interest on a semi-annual schedule allowing the ability to tailor cash flow to meet individual needs. Preservation of capital is another reason to turn to bonds as an investment. Although bonds can be purchased along a wide spectrum of risk, portfolios of highly rated bonds can serve to protect capital unlike any other investment option.

Like any investment, the potential return you may receive buying a bond(s) entails potential risks. You should always be ready for unexpected changes to your future investment returns. The hope is that those unexpected changes will be positive but that is not always the case. You may find more information on risks to buying bonds at: https://www.finra.org/investors/investing/investment-products/bonds#risks And risks to buying municipal bonds at: https://msrb.org/Investment-Risk

• Interest Rate Risk: When interest rates rise, the price of existing bonds typically falls. If you need to sell your bond when interest rates are rising, depending on when you purchased the bond, you may get less than you paid for it.

• Default and Credit Risk: If a bond issuer fails to make an interest or principal payment on its bonds as they come due, it is said to be in default. There are many reasons why this may happen but most likely the issuer is having financial difficulty and the result, in most cases, being a lower market price of your bond and you may not receive income payments in the future. Sometimes the issuer will recover after going through a “reorganization” however the amount of funds you expected to receive when you first bought the bond(s) will typically be much less and your return will most likely be negative with the potential of losing all of your investment. Or even if all payments are being made when due by the issuer, the credit rating of a bond may be lowered due to issuer financial difficulties of various kinds, which most likely will result in the market price of the bond being reduced. Again, if you need to sell your bond after the credit rating is reduced, you may get less than you paid for it.

• Liquidity Risk: If you need to sell your bond(s) before maturity, there are many factors that may influence the market price you receive, including interest rates and credit ratings. In addition, some issuers are smaller than others (they offer a fewer number of bonds to the public); the bond may have features or attributes that are not attractive to buyers in the current market; or general economic conditions may not be favorable to bond buyers; all of which may lower the market price of your bond(s) because of lower liquidity.

• Call Risk: A bond may be paid back to you before its maturity date because of a bond call provision or a refunding provision. You will receive the principal amount (sometimes maybe a little more) of the bond earlier than expected. However, the issuer will no longer pay the income on your investment that you may have been expecting and may result in your future interest income being lower than you budgeted for because you are unable to find another bond or other type of security that offers the same income stream or investment return. It is very important that you ask your investment professional about any bond provisions that may result in something other than receiving interest payments until, and the principal amount of the bond at, maturity date. You should also review the offering statement, most issuers have one, for the bond you are buying before you buy it. Never hesitate to ask your investment representative any questions you have. When it comes to money, there are no stupid questions!

• Reinvestment Risk: Whether you receive the principal amount of your bond investment earlier than you expected or receive the principal amount at maturity as you expected, assuming you want to continue receiving a return by investing the same funds, you may have to reinvest in another security or buy another bond that does not provide you with the same or a better investment return. Also, you may have a lower income stream in the future.

• Legislative Risk: When the government, whether at a state level or at the federal level, passes a new law that could impact your expected rate of return or credit worthiness of your bond; for example, a change in the tax code.

• These types of risks are not all inclusive: Please review the links provided for more information.