Bonds include these 5 risks

Ken Fisher, special in the United States today

Posted at 10:03 AM and May 19, 2019 | Updated at 11:31 am ET on May 19, 2019

Earlier this month, my column covered the basics of bonding – their operation and purpose in a mixed growth portfolio. But many see a 100% (or very heavy) bond portfolio as a safe income generator.

Taking into account various risks shows why bonds alone are rarely the best for retirement cash.

1. Interest rate risk.

Bond prices and interest rates are moving in opposite directions. When interest rates rise, bond prices fall. Rates are likely to increase little in 2019, but when they do, selling before the end (to deal with an expense, perhaps) causes losses.

2. Credit risk

Also called risk of default – potential that a bond issuer withdraws from the contract. When the issuer can not make any payment of interest or principal, it is defaulted. Depending on your bankruptcy order, you may not get your money back. When Greece defaulted in 2012, bondholders suffered huge losses. Higher credit risk bonds have high interest rates – attractive – but this only rebalances the greater probability of loss.

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3. Liquidity risk

With individual bonds rather than a bond fund, you can create problems at the time of sale. Many bonds, especially corporate bonds and municipal governments, do not trade much. This can make it difficult to quantify and find buyers. Most bonds are not like stocks, which trade daily on public stock exchanges. Selling can be slippery than the good promises of a politician. You can not sell at a glance at prices found online. Selling a "thin" bond to a few buyers may force you to sell with significant discounts – especially if there is no buyer and you need the product quickly for unexpected reasons .

4. Reinvestment risk

Owning high-interest bonds from low-risk issuers – and planning to hold them until maturity – may seem infallible. Yet even here, risks are hiding. Many corporate bonds are callable, which means that the issuer can redeem them at will. Businesses often do this when interest rates go down. Why continue to pay the highest rate when they can call the bond at a lower price than the market and offer a new cheaper one? Good for them. Bad for you.

Even if your obligation is not called, problems can occur when it expires and you must replace this revenue stream. What if you can not find something with a high enough return? A 30-year-old 30-year US Treasury yielded more than 8% a year. Good luck finding this with a low risk of default now! The current US yield over 30 years is less than 3%. You can not even approach the 8% in Greece! His 25-year debt is only 4.3%. You would need a 30-year Mexican or Brazilian bond for an unprecedented credit risk.

5. Risk of inflation

Few bonds have interest rates indexed to inflation. Normally, the interest is the same each year. When the link expires, you get the exact face value. Over time, even low inflation erodes the purchasing power of interest income. Ditto for your principal. With a 10-year bond maturing, the $ 1,000 you receive will buy you a lot less than when issued in 2009. To maintain the buying power, your money must grow.

Do not mistake yourself. I like links. Unlike many investments, they are transparent, with definable risks, and react exactly in proportion to these risks – unlike many non-transparent and complexly defined investments, say many annuities (in my column of 14 April).

So, they are a good tool but, like any tool, they must be used correctly, eyes wide open on their risks.

This is generally what needs to be done as part of a larger, growth-oriented mixed portfolio in which the role of bonds is primarily to provide relative stability by mitigating volatility.

Ken Fisher is the founder and executive chairman of Fisher Investments, author of 11 books, including four New York Times bestsellers, and ranks No. 200 on Forbes' list of 400 richest Americans. Follow him on Twitter: @KennethLFisher

The views and opinions expressed in this column are those of the author and do not necessarily reflect those of USA TODAY.

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