How to Read Bond Ratings Charts

Investors need some way to gauge the risk of buying a bond. While many investors think that bonds are generally safer than stocks, this isn't always the case. Bonds risk dwindling profits when interest rates fall and forfeiture of the principal if a company defaults on the bond. Investors need to know how to read bond ratings charts in order to estimate the risk of a security.

Instructions

Difficulty: Moderately Easy

Things You’ll Need:

• Prospectus of your bond investments

1. Check financial websites for current bond ratings charts. The most common and widely used rating systems are done by the financial institutes of Moody's and Standard and Poor. Ratings can often be found on the business section of media websites or in the prospectus of a bond.
2. Read general information from the rankings. Bond ratings charts look a little like a report card. The most secure bonds have A rankings, average bonds have B rankings and junk bonds are rated C.
3. Learn that Moody's uses a combination of capital and lowercase letters while S & P uses all capital letters. So an average Moody's ranking is Baa while an S & P rating would be BBB.
4. Compare the 2 different rankings for your bond to see if the ranking system is consistent. Sometimes one bond will be given a different ranking from each company, but this could be because one of the ratings is outdated. It may take several days to adjust all of the bond rankings after a large change in the market.
5. Minimize your Ba and BB holdings. These bonds are considered high-risk and shouldn't make up more than 5 percent of your total portfolio. Bonds below this ranking are dangerously close to defaulting and there is a high chance you'll loss your principal investment.

Tips & Warnings

• Most government bonds are given the highest ranking of Aaa or AAA. There is little to no chance of the government defaulting on these bonds because tax money is used to pay for them.
• Bonds listed high on ratings charts have an increased chance of default as their lifetimes increase. So, an A-grade bond for 20 years has more risk associated with it than an A-grade bond for 5 years. The longer bond will be exposed to more changes in the market, which could decrease the interest rate or cause the company to default.
• When you read a bond ratings chart, try to look at how the rating for one bond has changed over the past year. A low-rated bond that's moving up the ratings chart is a better investment than a high-rated one that is moving down.