Magazine article The CPA Journal

Sell before Maturity - and Increase Your Bond Returns

Magazine article The CPA Journal

Sell before Maturity - and Increase Your Bond Returns

Article excerpt

Buy and hold. If your clients are like most investors, this is probably their approach to bonds. The problem is, buy-and-hold investing means giving up extra return that's available at no extra risk. In my experience, systematically selling before maturity is generally the better course.

To understand where the extra return comes from, recall that longer bonds typically yield more than shorter bonds. What's often overlooked is that a bond's price generally rises after purchase merely because it becomes shorter as it is held and yet continues to pay the higher interest of a longer bond. This is known as "rolling down the yield curve." The fact is, if all else remains equal, a bond is worth more as time passes and can be sold at a profit.

In the exhibit, for instance, a four-year bond is issued at a rate of 6.39%. A year later it generates the same amount of interest, but it is now a three-year bond, competing with securities paying only 6.22%. The bond now has an advantage, and its price in the market rises. Another year passes; it is now competing with bonds yielding still less, and so its market value rises further.

Unfortunately, this price rise eventually comes to a halt, and then begins to erode. After all, at maturity the bondholder will receive par value only. …

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