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Interest rates can kill bond investing

Marketplace Staff May 17, 2010

Interest rates can kill bond investing

Marketplace Staff May 17, 2010


Steve Chiotakis: Those investing in Treasury bonds are hoping for long term returns. But that investment’s not a sure thing. And you could lose money on the deal. Fortune Magazine’s Allan Sloan told me to bring $1,000 to the table so he can explain how the bond market could really hurt my investment. He’s with us right now. Good morning, Allan.

Allan Sloan: Good morning, Steve.

Chiotakis: So all right, my thousand is in. In simple terms, why should I be concerned about keeping money in the bond market?

Sloan: In five words: interest rates could go up.

Chiotakis: That’s pretty simple. All right, so let’s do the math. If I have 30-year bonds that are expected to generate interest, how on earth can that be a bad deal?

Sloan: Well let’s say that you have a 30-year Treasury bond. And the rate, the interest rate on that is now 4.5 percent, which in fact it is. You’re making $45 a year. A year from now, for whatever reason, let’s say interest rates on that bond are 5.5 percent. You’re making $55 a year of interest on your money, right?

Chiotakis: Right.

Sloan: You can figure that out. No one is going to pay you the face value of your bond because it’s paying $10 a year less interest than you could otherwise get. So, in fact, it would sell for roughly $0.85 on the dollar. If you decided, well, I’m Chiotakis, I’m in here for the long run, you would get $10 a year less for 29 years than you could get if you had a higher-income bond. And you take your loss that way. You know, it’s like the old thing, pay me one way or pay me the other way.

Chiotakis: And assume, Allan, if interest rates drop, if they go down, does that mean there’s an opportunity for me to make more money?

Sloan: Oh absolutely. If interest rates are 3.5 percent in a year, which they won’t be, but if they are, your bond would be worth 118 cents on the dollar because you’d be making $10 a year more for 29 years than other bonds would make. But I would not bet on that.

Chiotakis: So then, Allan, what have we learned today about investing in bonds?

Sloan: That investing in bonds can actually be exciting when you don’t want it to be because changing interest rates can either kill you or help you depending on which way the world moves.

Chiotakis: Fortune Magazine’s Allan Sloan is with us this morning. Allan, thanks so much.

Sloan: You’re welcome, Steve.

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