Brighter economy may dim bond’s appeal

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Editor’s note: This is a transcript of the audio file.

Everyone wants the economy to improve but a quickening economy can be dangerous for one set of investors: bond holders.

I’m Sheyna Steiner with the personal finance minute.

The possible problem is the threat of inflation and, ultimately, higher interest rates. Existing bonds, with lower fixed rates, would be less attractive.

Rising interest rates cause the value of existing bonds to drop, producing a loss if you have to sell it before maturity. Holding a bond to maturity does negate that problem, investors who bought bonds at face value get their principal back at the end of the term.

But there is inflation to consider. If inflation has surged in the years you were holding the bond you will have lost purchasing power.

But bond fund investors stand to lose the most if interest rates and inflation creep up. Many bond funds hold long-term maturities. Longer term bonds pay higher interest but their prices will be impacted far worse by any surge in interest rates.

For more on this and other personal finance issues, visit I’m Sheyna Steiner.