In last post, we discussed the reasons why some individual investors want to buy individual bonds.
Below we will present reasons against owning individual bonds. If you are looking for steady incomes, you can consider bond funds.
1. Inflation risk
With interest rates projected to rise, so are inflation rates. Even if you hold individual bonds to maturity, inflation will erode your values.
2. Individual issue risk
If you just hold a handful of individual bonds, your ability to absorb any default shock is very limited, so chances are you will have to stick to high quality issues. But for bond funds, with enough diversification, they can take on more risks and chase higher yields.
3. Trading risk
Try to sell your individual bonds you will find it typical for the bid price to be a couple of percentage lower than the bonds' true value. The reason is no professional wants to buy the small bond pieces an individual investor owns. There is no problem for you to sell a bond fund at its net asset value.
4. Yield risk
Individual investors owning individual bonds are hard to avoid yield risk, but bond fund managers can use derivatives to adjust to the sensitivity of their bond funds to changes in yields, consequently will lose little to nothing in a rising interest environment.
5. Knowledge risk
As an individual bond investor, it's hard to do a thorough work to asses an individual bond's safety; bond fund managers typically have access to teams of bond analysts whose job is to do thorough research on the bond issues.
Below we will present reasons against owning individual bonds. If you are looking for steady incomes, you can consider bond funds.
1. Inflation risk
With interest rates projected to rise, so are inflation rates. Even if you hold individual bonds to maturity, inflation will erode your values.
2. Individual issue risk
If you just hold a handful of individual bonds, your ability to absorb any default shock is very limited, so chances are you will have to stick to high quality issues. But for bond funds, with enough diversification, they can take on more risks and chase higher yields.
3. Trading risk
Try to sell your individual bonds you will find it typical for the bid price to be a couple of percentage lower than the bonds' true value. The reason is no professional wants to buy the small bond pieces an individual investor owns. There is no problem for you to sell a bond fund at its net asset value.
4. Yield risk
Individual investors owning individual bonds are hard to avoid yield risk, but bond fund managers can use derivatives to adjust to the sensitivity of their bond funds to changes in yields, consequently will lose little to nothing in a rising interest environment.
5. Knowledge risk
As an individual bond investor, it's hard to do a thorough work to asses an individual bond's safety; bond fund managers typically have access to teams of bond analysts whose job is to do thorough research on the bond issues.
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