Risks of Investing in Corporate Bonds Today

An article in today's WSJ discusses the risks of corporate bonds, which are a popular investment vehicle today. The biggest risk seems to be the potential for inflation and future higher rates.

An article in today's WSJ discusses the risks of corporate bonds, which are a popular investment vehicle today.  The biggest risk seems to be the potential for inflation and future higher rates.  If you lock in a corporate bond today paying 5% and the inflation rate goes to 7%, then you are losing 2% a year after factoring in inflation.  If the Fed decides to put the breaks on inflation by raising rates to 10%+ then you'll have the opportunity cost of only receiving 5% when you could have had 10%.

I actually think the second scenario is more likely.  Once the Fed sees an upstick in inflation, it will raise rates.  Thus, I think run-away inflation is unlikely.  I do think that bonds yields will rise because of this and we're already seeing long-term bond yields go up in anticipation of this.  But if you're happy with a 5% yield and can live with it, then a corporate bond may not be a bad investment.

In the Journal article, the author indicates that equities may be a preferable option because they do better in times of inflation. Companies raise dividends and can raise prices to offset inflation.  But equities do not do so well in high interest rate environments.  And bonds, despite being considered a "more boring" investment have actually provided a higher rate of return over the last 90 years than equities when the latest bear market is factored in.  If you were a Japense investor, bonds would have been a far more preferable investment as the Nikkei has stagnated for 30 years.

 

Sam Cass
Sam Cass: Sam Cass, MBA, JD, University of Texas at Austin. Always a fan of Leonardo Da Vinci.

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