Long Term Bonds

The bond market, though not as large as the equity market, is just as important for investors as is common stock. In melding together long term bonds with equity investments, the average investor can mitigate excessive risk, create predictability, and reduce exposure and ultimately reliance on ever increasing stock markets.

Long term bonds are the most common on the exchanges. As the yield curve requires that bonds pay higher rates as the amount of time extends further and further into the future, long term bonds are a favorite among investors who want to maximize their annual returns. Though the risks are larger, especially in terms of credit and default risk, long term bonds are still interesting enough to attract investor attention.

Long term is usually defined as a period of greater than 10 years, with no real cap on the maximum date to maturity. The 30 year US Treasury, which is one of the longest dated fixed income debt instruments, has been given the name “long bond” among active investors. If you were to call your broker tomorrow and demand that he purchase a $100,000 “long bond” for your portfolio, he would know immediately that you wanted to buy into the 30 year Treasury.

But the “long bond” doesn’t just exist for national governments. Municipalities—cities, townships, and local governments—often issue debt with 30 year maturities. Mortgages, which trade on the financial markets as mortgage-backed securities, are often issued for as long as 30 years. Blue chip corporations, those that have been around for more than a few decades, and have often reached a market capitalization (total value) in the amount of billions of dollars, are also keen on issuing long term bonds for investors to buy and sell.

Going Super Long Term
Extremely long term bonds, those issued for terms of 50 to 100 years, are rare, though they do exist. Such bonds are often issued by large corporations, many of which exist in industries where risks are minimal. Railroad and utilities firms, for example, have very few risks that would prevent the companies from making good on their debt. They may also have large assets which can be put forth as collateral.

While individual investors are unlikely to purchase bonds for terms of 50 years or more, many institutional investors are empowered with the capital to make such purchases. Life insurance companies are a perfect target market, as most US-based life insurance companies have been around for centuries. Other insurance companies, such as those in the catastrophic market, are likely to hold long term bonds, since payouts to their customers are infrequent, and many insurance companies rely on long term holdings to reduce total cash exposure.

Risks of Going Long Term
As mentioned above, there are two risks that investors should consider before purchasing long term bonds:

1. Credit risk – By issuing debt 20-30 years into the future, companies have to assure investors that the company will still be around to return their principal investment 30 years from today. While most companies that are publicly-traded do live through multiple decades, the longer the term, the less likely is the return of principal.

2. Interest rate risk – Since monetary policy decisions tend to be made in cycles, there is substantial risk that rates may rise or fall after the bond is issued. When interest rates fall, the value of the bond rises in the short-term; however, when interest rates rise, the price of bonds decline. If you do not plan to hold a bond to maturity, it would be wise not to own it. If you do plan on holding bonds in the future, then extend your investments as far as possible, so as to achieve the maximum return on your investment.

Average Maturity Date
Investors often appreciate a diversified bond portfolio to combine the costs and benefits of short and long term bonds while maximizing returns. To calculate your average maturity date, take a dollar-weighted percentage of assets to multiply by the length of the holding.

A bond investor with $10,000 in 5 year bonds, and $20,000 in 20 year bonds would have an average maturity date of 15 years. That is to say that $20,000 is weighted heavier at 20 years, thus pushing up the average maturity date, even though the investor does not own any bonds that actually mature in 15 years.

If the same investor were to have $10,000 in cash, and $20,000 in 30 year bonds, he or she would carry an average maturity date of 10 years.

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