Bonds never lose the face value. Their market value may drop as interest rates rise, but if you keep the bond to maturity, you are guaranteed the face value. So if you bought the bond for interest income, you don’t have to worry about bond value dropping.
And what do you mean corporate bonds are not guaranteed? Of course they are guaranteed by the corporation. If you buy a Bell bond with a face value of 100$, Bell guarantees to pay you 100 $ at the maturity (or earlier, if Bell recalls the bond earlier). The only way you won’t get your 100 $ is if Bell goes belly up.
If you buy corporate bonds from big corporation such as Bell, any of the banks etc., they are quite safe. If you buy junk bonds, that is a different story. But provided you hold government bonds or corporate bonds issued by big reputable corporations, they are quite safe.
As to long bonds, again it depends upon why you bought them. If you bought them for the interest income, why would you care if they drop in value? How is that going to hurt you? It will hurt you only if you sell. Hold it to maturity and you are OK.
SJP for someone who posts about how successful his investments are and then posts advising other how to invest you really don't seem to know much about the bond market.
I freely admit I do not know much about it either, but then I don't make posts advising people to buy bonds.
So, because you seem to have no idea what I was talking about before here is a short primer on bonds.
Bonds always move inversely to interest rates.
That is the actual bond value itself not the rate of return.
An investment portfolio should contain between 20 and 35% bonds (on average).
This is to hedge against rising interest rates and to provide stability in choppy markets.
It takes quit a bit of money to actually hold physical bonds in an investment portfolio because the bonds always need to be laddered.
Laddering a bond portfolio is actually quite tricky and I, personally would not attempt it.
Remember the old Canada Savings Bond that grandma purchased for you on your 12th birthday?
That was then.
CSB's have virtually no place in a bond portfolio these days.
CSB's are returning 1% on one year and 1.8% on three years.
Banks like ING and Ally will give you 2% on a daily interest internet savings account and the first 100 thou is guaranteed by the Government of Canada.
So only an idiot would buy into CSB's right now.
SJB was asking me why long bonds are risky and saying that they should be held to maturity.
That tells me either SJP doesn't hold a bond portfolio or he has no clue how bonds as investments work.
A laddered and properly structured bond portfolio indeed will be selling and buying bonds before maturity.
There is far more money to be made in buying and selling bonds on the bonds underlying value than there is sitting around waiting for them to mature.
A proper bond portfolio would probably contain a few zero coupons or stripped bonds which provide no return at all.
Here is an example of making money on a bond. This is made simply to illustrate a point.
Back in 1980 Joe Blow buys a 100 dollar 50 year CSB (no such thing bye the way) at 20% interest.
Joe holds the thing to 2010. 30 years at 20% interest pays Joe $600 bucks and he still has his $100 in the original bond.
So Joe decides to sell it.
Well, obviously its going to cost more than a $100.
There is $500 on the table, so lets say Joe tries to flog it for $375.
That is an example of two things: selling a bond before maturity for a profit and number two making a bundle on a long bond purchased during times of high interest rates and dumping in times of low interest rates.
Remember I said earlier that bonds always move inversely to interest rates?
Well, purchasing a long bond in times of low interest rates and then having to sell it during times of high or rising rates would be the exact opposite of what Joe Blow pulled off and the value of your long bond would be crashed lower than whale $hit.
The Bank of Canada's set rate is now virtually zero, CSB's are paying under 2%.
Anyone but me think interest rates will be going up in the next 3 to 5 years, considering it's pretty much physically impossible to go lower?
So SJP, that is why I feel it would be stupid at this point in time to buy a long bond.
And as to the holding the long bond to maturity logic, that is flat dumb too.
If interest rates are climbing or going to climb and your money is locked for a long time at minimal return you are loosing money constantly sitting on the bond and not having it available for reinvestment at far higher returns.
Thats why the long bond value would be plunging in the first place.
On to corporate bonds.
In my original post I stated that corporate bonds were not guaranteed and SJP was wondering what I was talking about.
Only bank accounts of under 100 thou in Canadian charter banks and Canadian Savings Bonds and GIC's are guaranteed by the Canadian Government.
Corporate bonds you take your chances.
When a company defaults or hits the skids the banks get their money out first.
Next up on the carcass are the bondholders, then preferred share holders and finally common shareholders.
So SJP, thats why there can be quite a bit of risk in holding bonds.
And as to blue chips, you mean like Enron,Dodge,Lehman Bros,Delta Airlines, Bank of America and the like?
A good laddered bond portfolio will of course be holding a blend of high risk and low risk bonds.
If a higher risk company looks like it will go under you dump the bond at a loss.
If a higher risk company suddenly looks golden you can sell the bond for a profit or sit on it for higher returns at a lower risk rate.
In times of potentially increasing interest rates you should be shortening the maturity lengths on your bond portfolio.
And in times of high rates with a possibility of lower future rates you should be buying longer bonds.
Fact is, most folks cant afford to buy all these various investments.
And you need serious cash for bond brokers to get you the good deals on bond prices (and yes they do sell the exact same bond issue for different rates to different investors).
So they buy a bond holding mutual fund.
Which charges a fee to ladder the bonds and buy and sell bonds to tune the fund for maximum return (and tax leverage).
The fee is usually a killer in comparison to the fund returns and once again the little guy with only a few bucks to invest usually gets stiffed.
So there you have it SJP, bonds in a nutshell.
No longer do you buy them and stick them under the mattress.
Today you actually need to participate, or you need to hire someone to do it for you.
A few rules for would be investors.
Do not listen to SJP.
Do not listen to Trex, I freely admit I dont know much about bonds.
Do not get financial advice from internet boards.
Hire a good financial advisor or if you are into mutual funds try hard to get a well recommended broker who will refrain from churning your account and ease off on the hidden costs.
Trex
