
Click to Open Table of Contents >>>>>
Inflation Risk for Bonds Investors
Almost all bonds have inflation risk. I learned this firsthand in the early 1980’s runaway inflation days when my dad was able to buy municipal bonds for 50 cents on the dollar. This means investors on the other side of his bond purchases were selling those same bonds at 50 cents on the dollar. Now that is risk. Ouch! Here’s what happens with inflation and why it hurts bonds so badly in two ways.- Income from bonds loses purchasing power as inflation occurs or rises.
- And the value of the bonds decreases.
In the video below I talk about inflation risk from bonds in point #1.
Real Returns from Bonds
The yield an investor gets after deducting inflation is called the real return. This tells us a lot, right? Even if a bond has a 7% yield and inflation rises to even the historical average of around 3%, the real return is only 4%. If taxes are owed on that bond income, an investor could potentially knock off another percent or two. And don’t forget to consider any wealth management and (or) fund fees, too, offsetting the yield even more. Click here to read my post with more about wealth manager fees.Bond Risk from Rising Interest Rates
When interest rates rise, the value of bonds decreases. And the longer the duration of the bonds, the more the bonds decrease in value since investors are locked into lower yields for longer than they would be with shorter term bonds. This is logical, as most investing is. No investor wants to hold lower yielding bonds when they can get higher yields from new bonds. Click here to read my post How to Understand Your Investments with more about this.Credit Risk from Bond Investing
Bonds are subject to company risk, like AT&T, for example, or entity risk, such as a government or municipality. Municipalities that issue municipal bonds go under at times, for example. Fear of municipalities going under were also a factor in driving down the price of the municipal bonds my dad bought that were mentioned earlier. There was a bad recession in the early 1980’s. Investors feared that municipalities would go broke. My dad bought a cowboy hat, got in his very used Mercedes (with which he had a love hate relationship) and drove to Texas to check out many of the municipalities to assess if the risk was overblown. And he diversified among the municipalities to lower credit default risk. Also, global bonds are subject to the risk of a country going under. And companies do go bankrupt on occasion. One important risk lowering factor for bond investors is that bond holders do get their money back before stock investors in the event of liquidation, making them slightly less risky. Fortunately, there are ratings for most corporate and entity bonds that income investors and wealth managers use to evaluate the risk of bonds or bond funds. Click here to read my post on the risks of income investing.Bond Risk from Cycles

U. S. Treasury Bonds for Lower Risk
U.S. Treasury bonds can behave completely differently than higher risk bonds. In times of increased financial turmoil, higher risk bonds drop. They have have leverage, which can lead to trouble during hard economic times. But U.S. Treasury bonds are considered the safest investment other than cash or cash equivalents. This is why they almost always increase in value when stocks decline. (See the chart lower in this post.) And this is why many investors are unaware of the risks of bonds: There is a general perception that bonds are a “safe investment” that will never go down. But there is a big difference between a safe investment and an investment that won’t go down. While it’s unlikely Treasury bonds will have credit problems (we just print more money-yikes!), Treasuries are still subject to interest rate risk just like other bonds are. Treasury bonds rise and fall in value in relation to the economy, or more aptly put, economic “expectations”.Treasury Bonds in 2008
The past provides valuable information for proactive investors who choose to use it. So let’s see how Treasury bonds did during 2008, which was in the midst of the financial crisis and related bear market. We do this by checking the performance of a fund (Exchange Traded Fund, or “ETF”) that represents Treasury bonds in 2008 because we have reliable data from this. Since TLT is a well established ETF which represents the 20+ year Treasury Bond, we’ll use it. For example, TLT had a positive return of 33.76% in 2008, but TLT had a negative return of 21.53 in 2009. (1.) This demonstrates the need for either a well diversified portfolio OR use of tactical investment strategies that ease out of overvalued assets and into undervalued assets to lower risk while building wealth. You can see in the chart I made below how bonds went up when stocks went down and vice versa from past bear markets in stocks. The two years between 1969 and 2018 when both stocks (S&P 500 index) and the Treasury bonds went down are shown in red. (Feel free to use this chart with a link to this post. It was not easy data to find!) (2.)
Call Risk for Bonds
Many bonds have call features. This means that if interest rates decline, the company or entity that issued the bonds can call them from the bond holder. In other words, you don’t get to keep the bonds. You’ll get paid the face value or an amount close to it. Like most investing, this makes perfect sense; the companies that issued the bonds can issue new bonds at lower interest rates.
Risks of Bonds Summary
The scary thing is that many investors think bonds are completely safe. This misunderstanding increases risk simply from lack of awareness. The good thing about bond investing is that the income should continue to flow into your investment accounts even if bonds drop in value. And Treasury bonds almost always go up when stocks go down, as in 2008. The bad thing about bond investing is that the income is usually depleted from rising inflation. Plus, net worth will drop from the decline in the value of the bonds. This is why it’s important to begin with an overall wealth plan to decide how much investment risk you want. Yep, you get to choose how much risk you want in your investment portfolio, so choose your risk level wisely._______________________
We looked beyond stocks and bonds to add diversified income streams instead of living off investments completely after stumbling upon early retirement. The best place to start is with my Ultimate Wealth Plan. You can get it here now. Thanks for reading. If you enjoyed this post, please share it with others on your favorite social media. Author: Camille Gaines – About
The information on this website is for education only and is not to be construed as personal financial advice.