6 Common Mistakes to Avoid When Buying Bonds

Debt instruments come in various forms, including fixed-rate and variable-rate bonds, debentures, certificates of deposit (CDs), and treasury bills. These financial tools are commonly used by both governments and corporations to raise funds for operations, infrastructure, or other key projects.

In simple terms, when an investor buys a debt instrument like a bond, they are essentially lending money to the issuer—who could be a government body or a company. The issuer, in turn, agrees to pay interest at regular intervals and promises to return the principal amount upon maturity.

The one who issues the bond is called the issuer, while the one investing in it is the bondholder. This agreement provides a predictable income stream for the investor and a structured repayment plan for the issuer.

While debt securities are generally considered more stable and conservative than equities, the bond market isn’t without its pitfalls. Even experienced traders can make avoidable mistakes due to oversight or misinformation.

Following are the six mistakes you should avoid while investing in Bonds

1. Failing to Understand Interest Rate Changes

Bond prices and interest rates clash. Bond prices drop when rates rise and vice versa. Near the bond‘s maturity date, the issue price fluctuates as the interest rate changes. Can this volatility be avoided, as many investors do? To do so, we must understand interest rate risks. When you buy a bond, you are guaranteed a certain rate of return, called the coupon rate.

Bond prices fall if markets rise after you buy them. Your bond will trade at a discount on the secondary market since the buyer will earn less. In a market downturn, the bond will trade at a premium due to larger coupon payments. Money supply and demand, inflation, and government fiscal and monetary policies affect interest rates.

Therefore, bondholders should hold their bonds until they mature; be ready to hold the bond until redemption. If you sell the bond before it matures and interest rates fall, you‘ll lose money.

 

2. Not Understanding The Claim Status

Always be conscious of the debt you are carrying, particularly in situations when the acquisition is backed by speculative activity. Bonds backed by specific forms of collateral are given priority over other bonds in the case of liquidation or bankruptcy. Subordinated debentures are paid before other debt instruments when claiming preference. Bondholders are allowed preferential claims over stockholders in the case of bankruptcy. In other words, if the issuer company declares bankruptcy, Subordinate Bond Holders are more likely to receive their full payment.

Check the certificate to see what kind of bond you currently own. It will in some way make the bond status known. You might also speak with the broker who sold you the bond; they can just update you on the situation. You can check the company‘s financial records if your bond is an original issuance.

3. Not Verifying Issuer Company‘s Background

To determine the consistency of the company‘s profitability and whether all tax, interest, and other obligations have been met, investors should examine the cash flows of the company‘s annual reports. This information is readily available in the company‘s management discussion and analysis to any prospective investor.

You may also learn about the company‘s previous inability to make payments due to any scenario from the proxy statement of the company. This enables you to assess the company‘s ability to meet its financial obligations in the past and predict its ability to do so in the future based on past performance. To make the bond you‘re buying seem less experimental, the goal is to understand the issuing company better.

4. Failing To Understand Market Perception

It is common knowledge that bond prices can shift in response to changes in the situation of the market. The price of the bond will go down if there is a widespread belief in the market that the company will be unable to pay what has been committed. Should something like this take place, it has the potential to damage the company‘s reputation. On the other hand, the price of the bond would go up in the event that the market had a positive opinion of the issuer or the issuance.

5. Not Considering Inflation

When inflation numbers are released, you should never disregard them. Inflation may have a substantial impact on the future purchasing power of a bondholder. Especially for purchasers of bonds whose yield is less than the inflation rate. In this manner, they ensure that they will incur a loss. This does not indicate that you should avoid investing in bonds with low yields issued by respectable firms. This is merely a reminder that you may safeguard your money from inflation by investing in other high-yielding bonds that pay higher rates.

6. Not Considering The Liquidity Factor

There may be information about the liquidity of the issue you own in financial publications, market data/quote services, brokers, or on the website of the company. More specifically, one of these sources may be able to tell you how many times the bond is traded every day.

This is important because bondholders need to know that if they want to sell their position, there will be buyers on the market who are willing to take it over. In general, the stocks and bonds of large, well-funded companies are easier to buy and sell than those of smaller companies. The reason for this is simple: people think that bigger companies are more likely to be able to pay back their debts.

Is there a particular amount of liquidity that is advised? No. However, if the issue is quoted by significant brokerage houses, and is traded in significant volumes every day, it is generally appropriate.

To summarise, compared to stocks, bonds are a safer and more conservative investment option. However, contrary to the widespread notion, investing in fixed-income instruments requires a significant amount of time spent on research and analysis. Those who do not prepare themselves adequately run the danger of receiving returns that are either poor or negative. In order to make appropriate investments in Bonds, you can always contact JM Financial Services

FAQs :-

1. What is the most common mistake bond investors make?

One of the most common mistakes is not understanding how changes in interest rates affect bond prices. Investors often ignore rate risk, leading to unexpected losses.

2. How does inflation affect bond investments?

Inflation erodes the real value of your interest payments. If your bond yields less than the inflation rate, your purchasing power decreases over time.

3. What is bond liquidity, and why is it important?

Bond liquidity refers to how easily a bond can be bought or sold in the market. Illiquid bonds may be difficult to sell quickly or at a fair price, especially in emergencies.

4. How can I check the background of a bond issuer?

You can review the issuer’s financial health through annual reports, credit ratings, proxy statements, and market analysis available on financial platforms or the issuer's website.

5. What does "claim status" mean in bond investments?

Claim status determines the priority of bondholders in case of the issuer’s bankruptcy. Bonds with higher priority (like secured or senior bonds) are safer than subordinated ones.

6. Should I always hold a bond until maturity?

Not necessarily. While holding till maturity ensures full principal repayment, market conditions, personal liquidity needs, or better opportunities may warrant an early exit—if the bond is liquid.

7. Where can I get reliable help for investing in bonds?

You can consult trusted financial advisors or use platforms like JM Financial Services to access expert advice and curated bond options.