Even after we gain a full understanding of the bond markets, it can still be a challenge for investors to implement those strategies.
We get questions around this, and Collin, one of the most frequently asked questions we hear is "Why would an investor ever
pay a premium for a bond?"
In other words, why would you ever pay a price that's greater than its par value?
Well, paying a premium for a bond doesn't mean an investor will necessarily lose money.
Bonds are priced at a premium because their coupon rates are generally higher than the prevailing interest rate.
So, for example, assume a bond has a coupon rate of 5%, but the prevailing interest rate is just 3%.
Essentially, you're paying a higher price for those higher-income payments.
Now, over time, the price of a premium bond will generally converge to its par value--but once again, those higher coupon payments that investors earn
help off-set some of those declines.
Now, investing in premium bonds do have a few benefits.
For one, many investors are a bit wary of paying that higher price for a bond that they know will mature at a lower price.
But because of that discrepancy, premium bonds often have slightly higher yields than comparable bonds that are priced at lower levels.
Premium bonds also have less interest rate sensitivity.
So, when compared to a comparable bond at a discount, for example, during periods of rising or falling interest rates, they'll generally see
lower price fluctuations.
Premium bonds do come with some risks, like call risk.
A bond that's callable means it can be redeemed by its issuer prior to its maturity date.
So if you're investing in a bond that's priced above its par value, take a look to see if there
is an upcoming call date to make sure that the price doesn't drop to par very quickly.
So, investing in a premium bond has its benefits, but it also has some risks.
Collin, does it ever pay for an investor to wait to invest in bonds and wait for interest rates to go up?
We always think that time in the market is more important than timing the market.
If you're waiting for rates to move a little bit higher, you're likely investing in lower-yielding alternatives and missing out on the higher yields
that other types of investments may offer.
We call this "the cost of waiting."
So, the longer you wait for yields to get to a level that you're comfortable with, the higher they'll eventually need to be for you to make up for that lost income.
So time in the market is better than timing the market.
We have a lot of resources available to you at Charles Schwab, including Fixed Income Specialists
dedicated to each branch, fixed income portfolio analysis, as well as income specialists.
You can learn more by contacting us.