Many people have run for the “perceived” security of owning bonds since the stock market crash in 2008.  But bonds aren’t quite as safe as the general perception out there.

Here’s why.

Let’s look at two bonds and you tell me how much you would pay for them.  First, there’s Bond-A.  Let’s say you paid $1000 for it and it pays $50 a year in interest.  Ok – that’s not bad so you are feeling pretty good about yourself for the moment.

Then along comes Bond-B.  You can pay$1000 for it and it pays $100 in interest every year.

Which bond do you want to buy – Bond-A or Bond-B?

I’m thinking Bond-B, aren’t you?  Because it pays twice as much interest for the same $1000 investment.  Everyone will want Bond-B, actually.

Which means no one will want Bond-A.  That is to say no one will want to spend $1000 to buy Bond-A.

So is Bond-A worthless?

No.

If people could buy Bond-A for half price, $500, because it pays half as much interest as Bond-B, they would be just as interested.  Because they could buy two of Bond-A for $1000.

What do we call the amount people are willing to pay for something?  We call that the price, don’t we?

Unfortunately, you already bought Bond-A for $1000 during the crash of 2008.

But now the price, if you want to sell it, is $500.  Oops.  You just lost 50% in the “safe” bond market.

So much for bond security.

Now just to be clear, if you hold Bond-A to maturity, you will get your $1000 back.  But between now and then, it’s price can move up and down much more than you think.  And with the threat of inflation on the horizon, that means it’s price will move down.

Because when inflation goes up, interest rates will go up.

And there will be a lot of people offering Bond-B to the public.  And many people willing to pay a lot for these bonds – as in bond bubble.

While you still own Bond-A.  And watch it’s price go down – as in bond crash.

So do you see why bonds aren’t quite the safe investment you thought they were?

To your health and prosperity – John Roberts