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Bond Basics: An Investor's Guide to the Many Meanings of Yield

Bond Basics: An Investor's Guide To The Many Meanings Of Yield Splash image

Let us assume that you are reading the financial pages of your favorite newspaper. You read that even though stock returns have been dismal for the last two years, bond returns have been very good. In fact, you read that over the past two years, many bond funds returned well over 15%. While the returns look pretty darn good relative to stocks, you may wonder: Does that mean I can expect to earn 15% next year if I buy bonds? If the answer is not obvious, read on.

The direction of interest rates is one of the chief determinants of bond prices. A strong market for bonds is one in which interest rates are declining. That causes bond prices to go up. A weak bond market is one in which interest rates are going up. That causes bond prices to decline. Clearly, then, since changes in interest rate levels affect bond prices, they also affect what you earn from investments in bonds.

But that is only the beginning. In order to understand what you actually earn from bonds, you need to understand two different concepts: yield and total return.

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Discussion

David Harned from Virginia posted about 1 year ago:

Excellent article. The only thing I would add is the risk of default which can happen with all types of bonds, including municipals. While it is true that individual stocks can also go to zero, there is usually a decline curve to watch and an opportunity to salvage some value. Buying individual bonds can be tricky which is why I believe most investors are probably better off with bond funds.


Joanne Husarik from Illinois posted about 1 year ago:

And now, how do I buy an individual bond ?????


Regina Mcconnell from New Jersey posted about 1 year ago:

The article certainly clarifies the distinctions among yields.
Understanding that a rise in interest rates results in a decrease in price of a particular bond,can I expect that a duration factor of 2.5 will compensate for this decrease in price if I remain in that particular bond fund for two and a half years?


Jean Henrich from Illinois posted about 1 year ago:

Joanne, Go to the Investor Classroom under Getting Started for a series on investing in bonds. The first article in the series discusses finding a bond broker:
http://www.aaii.com/classroom/getting-a-handle-on-the-bond-market

-Jean at AAII


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