Different Risks to Consider Before Investing in Bonds 5.00 / 5 (100.00%) 1 vote

Working with bonds can be a great way to help diversify your portfolio and generate additional income in accordance to how you plan on progressing in your trading career. While they can be invaluable to work with in a larger general sense, they can also be difficult because of the various risks associated with their investment. In order to make the most of your investments, it is highly recommended to remember these risks to consider before investing in bonds.

To begin with, one of the most important types of risks that are established in this field revolves around interest rates. Most bond prices and interest rates collaborate with each other in an inverse relationship. As interest rates grow smaller, the bond price will grow larger, and as the bond price grows larger, interest rates will fall. Taking this fact into consideration in your decisions will help you determine what investments will be sound in the long term against those that may be better for the short term.

There are numerous reinvestment risks associated with bonds as well. This type of risk focuses on the reinvestment process, which typically involves proceeding at lower rates than what the trader may have originally worked with. This type of risk presents itself when interest rates decline over time and callable bond options are exercised by those that issue the bonds themselves. This type of risk will often determine how you want to proceed after your initial profits.

Inflation risk is another constant real worry that many traders need to understand when they trade with bonds. When the investor plans on purchasing a bond, they will ultimately be committing themselves to receiving a specifically calculated rate of return, which works through an either variable or fixed rate in accordance with the duration of the bond. When these rates increase or decrease dramatically, investors will need to plan ahead in order to make the most of the situation.

Credit and defaulting risks are often another problem to think about. When investors purchase bonds, they are only actually purchasing the certificate of debt. What this means is that the borrowed money will need to be repaid in full by the selling company with relevant interest. What many investors do not realize is that corporate bonds are not fully guaranteed by the government, and rely on a degree of trust and cooperation.

Liquidity risk is another constant concern, and easily one of the most important risks to consider before investing in bonds. While there is a constantly moving market available for most types of government bonds, corporate bonds may seem like different types of investments entirely. A large risk revolves around liquidity, where the trader may not be able to sell their bonds quickly enough according to how thin the market may be, and will need to plan their investments and time their trades accordingly.