TMTW #121 – The Risks of Bonds Part II

Tax and Money Tip of the Week:
The Risks of Bonds – Part II
| December 12, 2012 | No. 121

Last week, we talked about the risk that inflation plays in the bond market. Continuing on that line, I wanted to provide you with a quick example of how rising interest rates due to inflation can have an effect on the value of bonds (and bond funds).

The table below illustrates how future increases in interest rates effects the value of a $100,000 bond purchased today.

    Bond                  Bond Value                    Bond Value
Maturity          with 1/2% rate               with 1% rate
                          increase in 1 year       increase in 1 year

  1 YR                        $99,500                       $99,035

  2 YR                       $99,020                       $98,060

  5 YR                       $97,825                        $95,700

10 YR                      $96,175                       $92,500

15 YR                      $94,900                       $90,150

20 YR                     $93,950                       $88,400

30 YR                    $92,650                        $86,125

With this quick example, you can see how even minor rate increases can erode the value of a bond.

The reason for this is that in a rising interest rate environment, new bonds would pay better yields; therefore when you sell your older bonds, you would lose money as buyers could obtain newer bonds with higher yields.

So, as I said last week, while bonds may appear to be that “safe” investment, remember that even bonds have risks that should be considered.
Questions or Comments?

You can add comments on the blog, call 919-847-2981, or visit our web site. We look forward to hearing from you.

Mark Vitek, CPA/PFS, CFP®
…until next week.

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