A bond maturity is the date upon which all of the initial investment plus interest will have been paid out.
That can be as short as a few months and as long as 30 years in the case of certain U.S. Treasury bonds. The level of interest paid is a function of the amount of time the money is lent, that is, how long until maturity.
Bond investors are looking for the highest interest they can earn. Understandably, borrowers that issue bonds, such as corporations and governments, want to pay as little as possible in interest cost.
The balance between these forces dictate the ultimate cost of borrowing via a bond issue. Once a bond is sold by the original issuer, it can be sold and resold on the secondary market as well.
In most cases, the risk of owning a bond is relatively low, especially for high quality corporate bonds and for government bonds, such as Treasurys and tax-free municipal debt.
If the interest rate falls after you buy a bond, the safe route is to hold the bond until maturity. That way, unless the issuer defaults, you are assured your money back plus the interest you earned.
That’s why many financial advisers feel that bonds are less risky than owning, say, stocks. A stock can fall in value and never recover. A bond should pay back its principal and interest.
Bond fund managers try to get a mix of maturities in order to maximize the return to investors while limiting risk.
By owning a variety of bonds at a variety of maturities, bond fund managers can sell bonds as they reach maturity and reinvest the proceeds into newer bonds.
The level of risk in the fund is usually measured in terms of the creditworthiness of the lenders in the portfolio. The average maturity of the portfolio is another measure of risk.
For instance, in times when interest rates are rising, a portfolio full of very long bonds is at risk of losing value on the secondary market. Investors can simply purchase newer bonds that pay more.
In times when interest rates are falling the same portfolio is a better bet, since those higher rates will be paid for a longer period before finally reaching maturity. If it becomes necessary to sell, the demand for those long bonds will be stronger.
In any case, for most long-term investors a bond portfolio is best managed as an investment to hold rather than trade.
The goal is to use the relative certainty of the bond positions to dampen the volatility of an overall portfolio that includes bonds, stocks and other asset classes.
While stocks historically have appreciated more than bonds, there have been short-run period when bonds were the better investment.
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