Short Term Bond Yields Vs. Long-Term Bond Yields
Investing in individual bonds and bond mutual funds is a good way to get current cash flow, but the yields on those bonds and funds varies quite a bit. In the bond market, yields are a product of both risk and maturity. Government bonds provide absolute safety of principal, but their yields tend to be quite low. Corporate bonds provide higher yields, but higher risk as well. For both types of bonds, the yield tends to go up as the duration of the bond increases.
Other People Are Reading
-
Individual Bonds
-
If you want to invest in bonds you have two distinct options, you can invest in individual bonds through a broker, or you can choose to invest in bond mutual funds instead. If you decide on an individual bond, you can choose from a number of different maturity dates, as well as a number of different companies. Generally, you can find higher yields by going out further and choosing a later maturity date, but that means you take on more risk as well. If interest rates rise after you buy the bond, that bond will go down in value, since higher yields are now available. You can, of course, hold the bond to maturity and still get your interest, but if you need to sell the bond early, you might get less than you paid.
Bond Funds
-
When you choose a bond fund, you will generally find that the yields go up along with the maturity, provided you are working with the same type of bonds. Government bonds are generally the safest, and as their maturity levels go up, their yields go up as well. The same is generally true of corporate bonds, although the yields on all corporate bonds tend to be higher than government bonds, due to the increased risk associated with investing in the corporate market.
-
Interest Rate Risk
-
Whether you invest in individual government or corporate bonds or bond mutual funds, you have the same type of risk, and it is important to factor that risk in when evaluating the yields on those funds and individual bonds. The yields on long-term bonds and bond funds tend to be higher than the yields on short-term bonds and funds, but those long-term bonds carry a greater level of risk as well. If interest rates go up after you make your purchase, the value of the existing bonds you hold goes down. That is because current investors can get more for their money, and the price of those older bonds must go down as a result. If you hold an individual bond, that means you might not get the same price you paid if you have to sell it early. If you hold a bond mutual fund, the net asset value declines as the level of interest rates goes up. Understanding this interest rate risk is a big part of learning to invest in the bond market.
Average Maturity
-
One way to limit the interest rate risk when investing in a bond fund is to examine the average maturity of each fund. The longer the average maturity of the fund, the more interest rate risk you are taking. If the bond fund you are in has a long average maturity, such as 10 to 15 years, you can expect the net asset value to decline sharply if interest rates rise quickly. If the average maturity of your bond fund is much shorter, perhaps only two or three years, the interest rate risk should be much less. If interest rates are at historical lows when you choose to invest in bond funds, it might be a good idea to keep your maturities short, even if that means giving up some yield in the short term.
-
References
- Photo Credit savings bonds image by Stephen VanHorn from Fotolia.com
