Typically when interest rates drop, investors rebalance their portfolios and buy bonds for stability to offset expected volatility in the stock markets - interest rates dropping is deemed a sign of a weaker economy that needs stimulating (less interest, means less debt obligations and more cashflow for consumers and businesses to spend on stimulating the economy). But, if you're like me, you like to buy bonds before interest rates start dropping.
Why?
As a quick recap, and so we're all on the same page, bond prices have an inverse relationship with interest rates, so when interest rates drop, bond prices rise - more on bonds here.
As interest rates drop, the bond market becomes more 'in-demand' (because of investors re-balancing their portfolios) and where there's demand there's growth, meaning bond prices rise - if you bought in beforehand you can say hello to those capital gains! If you're only buying in when bonds are already in higher demand, it means you're likely buying the bond at a premium price i.e. overpaying for it.
It is also important to remember that if you wanted to sell the bond before its maturity date (when the bond expires), you may not get back the full amount that you invested. This is because bonds typically trade at a discount or a premium and rarely at their true or face value.
This means that you will need to make enough money from the coupons (interest) the bonds are paying to make up for the capital loss to break even or to exceed the capital you invested to make a profit, if you buy when interest rates are going up.
Something to consider when 'following' the market.
Please know, the value of investments can go up as well as down and you may receive back less than your original investment, meaning, when investing your capital is at risk.
Disclaimer: At Evarvest we believe in making investing and investment education more accessible, but we don’t provide investment advice and individual investors should make their own decisions. While we try our best, we cannot ensure the accuracy of the information we provide.
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