How to Invest: Are you Vulnerable to Inflation Risk?
Personal Investments can lose value short, and long term.
Companies assets are devalued, when bought and sold
Government Policy can increase the rate of inflation
Over the years, investments can lose their value if the money invested in them losing their purchasing power. Inflation risk is particularly dangerous because there is no way to avoid it, because money itself loses purchasing power.
Fed’s Fisher Comments on Policy, Inflation, US Dollar It is the risk caused by the unexpected rise in production costs due to the inflationary process. The essence of inflation as an economic category is the growth of prices for goods, works and services, which reduces the purchasing power of money in the economy. This kind of risk can be applied especially on large damage long-term investments, such as investments in shares and bonds.
What is Inflation Risk, and how does it affect you?
Individuals and legal entities with investment portfolios advised to actively manage their investments to avoid the problems associated with the inflationary risk. Moreover, this type of risk is useful to consider the short and long term.
It is the risk caused by the unexpected rise in production costs due to the inflationary process. The essence of inflation as an economic category is the growth of prices for goods, works and services, which reduces the purchasing power of money in the economy.
Investments can lose their value if the money invested in them losing their purchasing power.
This kind of risk can be applied especially on large damage long-term investments, such as investments in shares and bonds. Inflation risk is particularly dangerous because there is no way to avoid it, because money itself loses purchasing power, regardless of whether or not they have invested.
Individuals and legal entities with investment portfolios advised to actively manage their investments to avoid the problems associated with the inflationary risk. Moreover, this type of risk is useful to consider the short and long term. Inflation is a characteristic of most of the economies, but in the short term, its negative impact is insignificant, and that the investor has received considerable losses during 1-2 years. In the long term the situation may look completely different. Under the influence of money market factors it may increase their purchasing (this process is called deflation), which is likely to lead to an increase in the value of shares and bonds. Therefore, the impact factor of inflation in the long run may not be as devastating as it is in the short.
Inflation is a characteristic of most of the economies, but in the short term, its negative impact is insignificant, and that the investor has received considerable losses during 1-2 years. In the long term the situation may look completely different.
Under the influence of money market factors it may increase their purchasing (this process is called deflation), which is likely to lead to an increase in the value of shares and bonds. Therefore, the impact factor of inflation in the long run may not be as devastating as it is in the short.
High Yield 8% Returns at 68 Years Old…
In 2004, at age 58, doctors told legal representative Jane Freeman that her pneumonia had caused brain damage and that she’d never be capable to force or balance a checkbook again, let by you practice law. So after 43 years in Colorado she was forced into an early retreat and moved to “God’s waiting room” Florida.
She has been able to invest over over 3 Million with an 8% Return.
Freeman went to work learning about investing online at a variety of websites, counting message board Valueforum.com. Her goal was to be able to supply at least $100,000 per year in income, without having to eat into her major. In the present day her brokerage accounts stand at $3 million, she takes two vacations a year and is already prepaying for two of her six grandchildren’s college educations.
Freeman spends almost all of her time researching high-yielding extra stocks that will pay her at least 6%, plus have a history of reliable dividends and forecasts of increases. She focuses on 20 stocks, and a third of her holdings are concentrated in the dividend-friendly stocks of companies controlled by Norwegian shipping billionaire John Fredriksen (Freeman is also of Norwegian descent).
Infrequently she wakes at 3 a.m., when the Norwegian stock market opens, to read Norwegian newspapers, visit shipping site Tradewinds and do some research before the trading day begins.
Despite oil’s decline Freeman likes pipeline MLP venture Products Partners (EPD, 37). It’s been her most lucrative MLP, and although the dividend is now 4%, down from 8%, it has never missed a payout, and she’s holding on. Williams Partners (WPZ, 50) is another natural gas MLP she likes. It has a 7% dividend yield and a growing presence in the lucrative Marcellus Shale.
How to Invest: Corporate Bonds vs Treasury Bonds
How to Invest: Corporate Bonds vs Treasury Bonds
Types of Bonds / who is issuing them?
Agency Bonds (Agencies):
Securities issued by government organizations and government sponsored entities or GSE’s make up a sector of bonds referred to as agencies. These bonds are generally appointed to assist in public aid, including agricultural and housing-related projects. The Government National Mortgage Association (Ginnie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), the Student Loan Marketing Association (Sallie Mae) and the Federal National Mortgage Association (Fannie Mae)
Are Bond investments Safer than the Dollar?
Treasury Bonds, What you should know before you invest
U.S. Government Bonds (Treasuries):
Treasuries are bonds issued and backed by “the full faith and credit of the US Government,” which makes them one of the safest ways to invest. They are not liable to credit risk in part because in order to “redeem the bond at maturity” the government can hike up taxes or print money. Treasuries usually provide lower yields in regard to other bonds and the income that bondholders receive is only taxed at federal, not local or state, level. The Treasury Bill is one way to invest through the federal government, with only 1 year to invest or less – it is considered one of the least risky methods of investment. Treasury Notes mature in 1 – 10 years and accrue a fixed rate of interest every six months up until the point of maturity. Treasury Bonds are US debt that matures in 10 – 30 years. T Bills, T Notes and T Bonds are all issued in face values of $1,000. A definite advantage of these Treasuries is that they are not callable, not to mention, they can be held in your name rather than the name of the brokerage firm.
More on Treasury Bonds
Municipal Bonds (Munis):
Municipal bonds function at the local, state and federal level, to raise funds for a project. When a purchaser invests in a Muni they are loaning the funds from the authority that issued it. In return, that authority pays a coupon rate until the bond matures. This interest rate paid to investors is tax exempt from federal taxes, and much of the time this applies to tax exemptions on the local and state level as well. Once the muni matures, the authority pays the par value. As you would imagine, munis help fund municipal government related ventures, meaning they may benefit you fairly directly if you purchase the bond at your local municipality. Munis can come in handy in the arena of city projects that relate to education, transportation and infrastructure, to name a few. At times, these bonds may be callable, which means the authority that issued the bond may pay off the principal amount before the maturity date, as well as the accrued interest and are eligible to cease paying their coupon payments. This will reduce the overall yield because the investor has less time to earn interest on it. Cities do not bankrupt often, but that might happen. The yield on this bond is basically lower than other taxable bonds.
There are two types of municipal bonds, general obligation bonds, which are not backed by a revenue source but are supported by the full faith and credit of the issuing entity. The issuer’s ability to levy taxes, particularly property taxes, supports the bond’s interest payments and repayment of principal. There may be a special tax considerations free from federal income tax. If you live in the city or county where this bond is issued, it’s possible you will be exempt from state and local taxes. These bonds are usually voted on as they help fund community-related projects. The bond elections are held to allow tax payers to vote on whether or not they wants taxes to increase to provide funding for a particular bond funded project or to reject the issuing of bonds which means there would have to be an alternative to raise the funds for the project. Some citizens may view the bond debt as an inconvenient expense while those of the opposite viewpoint will see it as a community investment. There may be special tax considerations earned on G.O. bonds. For example, the interest earned is often free from federal income tax. If you live in the city or county where this bond is issued, it’s possible you will be exempt from state and local taxes and may pay lower interest rates.
And like any bond, it comes with default risk; some municipal securities are covered by bond insurance, which can guard against risk. Insured bonds are underwritten by a private insurer that guarantees repayment if the issuer defaults. Since G.O. bonds don’t usually trade on an active basis they are very susceptible to the principles of supply and demand which exposes them to market risk when it comes to buying and selling. They are also subjected to interest rate risk, the risk that changing interest rates could affect your bonds value or reinvestment risk where funds are reinvested at lower interest rate levels.
Corporate Bonds (Corporates):
These bonds are available to both large and small companies to gain capital, set new products in motion, subsidize construction and/or cover any extra expenses that may exist. Corporate bonds function like most bonds, as the investor (in this case the company) must pay an amount (face) per bond that is issued. Each bond that is issued goes for $1000 and the investor must pay the bondholders a pre-determined amount of interest on a semi-annual basis. Once the bonds mature, the company (or investor), must pay back the principal amount to the bondholders as long as they haven’t defaulted in payment.
Corporate bonds can exist in the form of secured or unsecured bonds. The secured bonds are safeguarded by a pledged asset value that the issuer can designate as collateral. Because they are a high level of priority, these secured bonds are sometimes referred to as senior secure bonds. They are higher up in the ladder of individuals who get paid back, including subordinated or junior bonds.
Corporate bonds are also categorized according to asset type, including mortgages, financial obligations and machinery equipment among others. Mortgage bonds are secured by a lean on mortgage or property owned by the issuing corporation imparted to bond holders. Mortgage bonds are backed by assets that can’t be liquidated and are also considered high-grade, safe investments. Obviously, this goes to show that you can never tell under all circumstances and any investment can turn out to be risky in the end.
Collateral trust bonds are secured bonds that are backed by the issuer’s investments in other corporations. The issuing corporation may own stocks in other companies and may use them in the loan. Unsecured bonds are characterized as debentures. A debenture is not guarded by any kind of collateral – it is an arrangement made by a business to raise money for their investments.
Zero Coupon Bond:
A bond that does not accrue interest because there is no coupon payment. It is initially sold at a steep coupon price, lower than its face value, and once it matures the investor receives the principal amount. Any zero bonds in your account are taxable and can be viewed as a compounding interest income (yearly interest plus the principal), not a capital gain.
STRIPS are a type of zero coupon bond that stem from interest paying bonds. They stand for “separate trading of registered interest and principal of securities” rooted in Treasury bonds. An investment bank buys the bond but sells the interest payment separately. In this case, the strip bond is sold at a discount price but no longer burdens the investor with an interest payment. These bonds can be reinvested and convert their interest payment into a higher yielding bond but it can be sold on the secondary market before it matures.
Discount bonds only include the principal amount at their redemption and are issued below par.
Commercial Paper is a source of operational capital finance unassociated with the bank. It is said to be an unsecured promissory note at a fixed maturity of 1 – 270 days (nine months). They usually don’t have a developed secondary market, but many issuers redeem their commercial paper at maturity.
How to Invest: Bond Yield and Return Explained
Learning the Markets – Yield and Return Explained
Different Yield Types and Return Calculations
Current Yield: What the bond annually pays divided by the bonds current price. This tells investors what they’ll earn if a bond is bought and held for a year. When you invest in a bond that trades at a premium or discount, current yield is a misleading indicator for the total return you can expect. If you buy a bond, which is trading at a discount, the bond’s price will increase as it moves towards maturity. As the face value is greater than the price you paid for the bond you will have a gain that is not included in the calculation of current yield.
High Yield Bonds: rated BBB- at S&P and have higher required yield, similar to a maturity bond.
Yield-to-Call: If you’re a bond holder with a callable bond, you have calculated your yield to maturity, the rate of return you expect to earn until it matures, but you also need to calculate what happens if the bond gets called: the expected rate of return if the bond gets called at the first possible call date. It is calculated the same way as YTM through the five key approach. except
Yield-to-Maturity: This is the term which individuals usually use to reference the yield of a bond. It measures the amount the investor will be paid in the future and considers the coupon payments, the difference between the purchase price and face value and the return you should receive form re-investing the coupon payments. Bond prices behave as the inverse of interest rates. When interest rates surge, the value of an existing bond drops. When interest rates drop the value of the existing bond rises. When a bond is trading at a price below the amount you will receive from the bond at maturity, which is also known as face value, it is said to be trading at a discount. When it trades above face value, it is said to be trading at a premium. It calculates the expected rate of return, if we buy the bond today and hold it until maturity.
Yield-to-Worst is calculated on each of a bond’s call dates and is the utmost lowest possible yield that can be received on a bond without the issuer defaulting. It is a possibility that this calculation may result similar, even identical to the yield-to-maturity, but never higher.
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