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