Determining when it is a good time to buy a bond depends on a number of factors including the riskiness of holding the bond in lieu of investing elsewhere, the current financial health and holdings of the investor’s investment portfolio, and the risk tolerance level of the investor.
As discussed in part one of this series, bond prices drop when interest rates rise. This is generally a good time to buy a bond if the investor intends to hold the bond until its maturity date and realize payment of the principal. Keep in mind, however, that some bonds carry with them a ridiculously long maturity date, sometimes 50 or more years into the future. Therefore, other factors besides its price determine whether it is a good time to buy a bond.
Another important factor to consider when buying a bond is the investor’s current portfolio status. Bonds are less risky than stock ownership and, therefore, yield lower returns. However, these lower returns can help offset the riskiness of other securities held in an investment portfolio.
Although a good investor looks carefully at each investment opportunity, he/she cannot disregard the effect an investment will have on his/her investment portfolio as a whole. Buying too many bonds may make an investment portfolio too conservative to allow the investor meet his/her financial goals. Although a good, solid, and safe investment, low risk also means low return. Consider how the bond will affect your entire portfolio to determine the best time to buy bonds.
Another important factor determines a good time to buy bonds. Like the riskiness of the investor’s portfolio, this factor is determined on an individual basis. Risk tolerance is defined as the amount of risk (and, therefore, return) that an investor is capable or willing to take on when making investments. The easiest way to understand this concept is to think of the investor’s age.
Young investors have less to lose because they have a lifetime to make up for early mistakes. Older investors, especially those who are retired, have much more to lose because they can’t correct mistakes with time. Bonds, therefore, are not a wise investment at the early stages of one’s career because so much more could be gained by taking on more risk and realizing higher returns from alternative investments. Still, bonds can offset some of the risk associated with holding riskier investments in a portfolio. A good time to buy bonds is a mix among interest rates, bond prices, the effects of holding a bond in a portfolio, and risk tolerance.
Determining a good time to buy bonds is a complicated equation of market and individual investor conditions. Higher interest rates lower the prices of bonds making them even less risky to purchase and hold in an investment portfolio. A portfolio’s riskiness can be offset with the purchase of lower risk assets such as bonds but may make the portfolio’s risk so low that the investor isn’t realizing a high enough return. This is the opportunity cost of investing in one asset over another.
Finally, the risk tolerance of the investor helps determine a good time to buy bonds based on how much risk he/she is willing and should take on. In conclusion, both market and individual factors determine a good time to buy bonds. If you are unsure about adding bonds to your portfolio, consult with an investment professional who can assess both the market and your individual investment needs.
Richelson, H., & Richelson, S. (2007). Bonds: The unbeaten path to secure investment growth (2nd ed.). New York: Bloomberg Press.
This post is part of the series: Buying Bonds
This series discusses the factors that affect bond prices and when it is a good time to buy bonds. Learn how interest rates, investment portfolios, and risk tolerance all affect when it is a good time to buy bonds.