- We're going to go over three things that all investors should know about bonds.
Colin, what might investors see as a surprise when bond investing?
- Well, there isn't just one bond market, and there isn't just one interest rate.
The bond market is very large and complex, and there's a lot of different types of bonds out there.
Certain types of bonds, like U.S. Treasuries or certificates of deposit or investment-grade municipal
bonds, have very low risk.
But other types of bonds, like high-yield corporate bonds or emerging market bonds, do come with additional risks and are more prone to bouts of price volatility.
So if you're considering bonds, it's not as simple as just owning bonds in general.
It's important to identify the types of bonds that fit your risk tolerance and investing time horizon.
But there also isn't just one interest rate.
Different types of bonds can offer different yields, and even within a given type of bond investment,
the yields may vary based on the time to maturity.
And there are a lot of factors that can affect the yield that a bond offers.
- You told us about the difference between coupon and yield.
Can you tell us a little bit more about that relationship?
- The coupon rate is the interest rate that a bond pays based on its par value.
Generally speaking, most coupon rates are fixed.
The yield, or yield to maturity, is the total annualized yield an investor can expect to earn
if a bond is held to maturity, but it also takes into account the price paid.
Bond prices can move in the secondary market, and prices can be above or below its par value.
So the yield to maturity takes into account not just the coupon payments received, but whether the price will rise or fall to its par value by its maturity date.
So if you're considering investing in bonds, you don't want to look just at the coupon rate,
but what the yield to maturity is to have a better idea of what your potential total return will be
if held to maturity.
- Bond prices fluctuate.
Can you tell us a little bit more about the bond's relationship between its price and its yield?
- Bond prices and yields generally move in opposite directions.
Let's assume a bond has a 3% coupon rate--it's priced at par, so it offers a yield to maturity of 3%.
Now let's assume in a few months, the prevailing interest rate has risen to 4%.
Now this existing bond is only paying a coupon rate of 3%, so its price would likely fall
to compensate investors and offer a yield that's slightly higher than what its coupon rate is.
Now, this is important because when you own bonds, you want to have a better idea of how they might perform
given the interest rate environment.
So if yields are rising, bonds prices could fall--but the opposite is also true.
If bond yields are falling, they could actually experience price appreciation.
Now this won't necessarily matter if bonds are held to maturity.
- These are just a few of the most frequently asked questions.
You can find more information about bond investing on Schwab.com.