Bonds Are Riskier Than You Think

There are times in which bonds can be more dangerous than stocks

John Rekenthaler 26 December, 2016 | 16:37
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Bonds certainly sound safer than stocks. They are required to pay their stated interest rates, whereas stocks can cut their dividends at any time—if they pay dividends in the first place. Bonds, of course, also stand higher on the credit ladder. Should the organization go under, bondholders will likely receive at least a partial payment, sometimes even better than that. Stock owners will get nothing.

In addition, about half of U.S. bonds come courtesy of the federal government. General Motors, Kodak, Woolworth’s, Arthur Andersen, and American Airlines went bankrupt and stiffed their stock shareholders. While those companies would have liked to have possessed printing presses with which to pay their bills, they did not. However, Uncle Sam does. And its debts are denominated in the currency that it prints. The U.S. won’t be defaulting on its obligations any time soon.

This is all stating the obvious: People understand and appreciate the protections that are provided by high-grade bonds, particularly U.S. federal debt. Indeed, the term “government guaranteed” is so powerful that the SEC prohibits mutual funds from using it in their names. (The words once were permitted, but were banned when the SEC realized that many investors interpreted the term to mean that the fund couldn’t lose money.)

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John Rekenthaler  is vice president of research for Morningstar.

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