Learn To Earn: 5 Bond Trading Tips and Tricks to Keep in Mind
You probably already know that bonds are less volatile than most investment assets in the market. But this does not mean you can invest blindly. There are potential risks that come with investing in debt instruments, but we will show you how to work through them.
Bonds can be classified as speculative or investment-grade bonds. A speculative-grade bond is viewed as not being of investment quality by a credit rating agency. This is because the agency rates the issuer poorly, and considers it to have a high risk of default. Due to the high risks involved, speculative-grade bonds carry a high interest rate.
Investment-grade bonuses, on the other hand, are highly rated by credit rating agencies. They carry a lower risk of default and lower interest rates.
Here are five tips to consider before investing in bonds.
1. Define Your Objectives
What are your goals for investing in the bond? Do you want to grow your capital or maintain the principal value? When will you withdraw the money? Defining your objectives will help you choose the level of risk you are willing to take and pick the right investment strategy.
2. Do Not Focus Only On Yields When Investing
When you feel that the coupon payments are not as high as you would prefer, do not carelessly run for the higher yields offered by issuers with low credit quality. The high yields come with a higher risk and less security. Even when you are willing to take the risk, check the company’s financials and its past performance to assess if it can service its obligations.
3. Pay Attention to Possible Changes in the Interest Rate
Bond prices have a negative correlation with interest rates. During the period prior to the bond’s maturity, interest rates fluctuate, making the bond prices also widely vary. This is not the best time to sell the bond. The interest rate could change abruptly, causing you losses. It is better to hold your position.
4. Check the Claim Status
Although bond investors get the first claim to company assets if it goes bankrupt, not all bonds are equal. If you are investing in a speculative-grade bond, check that the bond will be given priority in case the issuer undergoes liquidation. Senior notes, for instance, are more secure than other bonds. They are repaid first before most other debts and are often backed by collateral.
5. Do Not Ignore the Issuer’s Reputation
The market perception about the issuer and issue can affect bond prices. If other investors think the bond will not perform well, the issuer will not meet its obligation, or if the issuer has a bad reputation, the value of the bond will decrease. Carry out background research first about the company before investing.
Conclusion
A bond may be conservative and less risky, but this does not mean you should be care-free when making your investment. First, define your goals and know your risk profile. You should also check that the company is capable of paying back its obligations. And finally, observe the interest rate moves before changing your position.