Why the Plunge in Puerto Rico Bonds Might Matter to You
I am concerned for people who have bond funds. I have a few reasons for this concern. First, I think that people have been misled concerning the risk that goes with bond funds. Bond funds are looked at as a safe way to invest money. The truth is that bond funds can and have lost money in the past.
Second, in the search for safety and higher interest payments, investors have flocked to riskier bond funds not realizing the risk that they are taking. There are two risks facing bond funds right now. The first risk is interest rates. Interest rates have no place to go but up. There is an inverse relationship between bond prices and interest rates. When interest rates go up bond prices go down. Bond prices have gone up for a very long time as interest rates dropped from 1980 until now. Investors have been lulled into this false sense of reality of bond funds equal safety.
Interest rate risk though should be the least of an investors worry. Bond money represents debt. When you put money into a bond you are in a sense loaning an entity money. In the case where you are investing into a single actual bond, they pay you the interest and then give you back your money at a certain time. Everything works out as long as there is no default. Price can swing all over the price and it doesn't matter. As long as you get your interest payments and get paid back at a certain time you are in good shape.
Bond mutual funds work different. They don't have that safety net. Price swings matter to a bond mutual fund. A bond fund doesn't promise to pay back the money. Defaults also matter to a bond fund.
Does your bond fund have Puerto Rico Bonds? You might want to find out. President Trump, in a very ill mannered move, said that Puerto Rico debt should be wiped out or forgiven. That equates to default! The Puerto Rico bond market plunged the following day. If your bond fund has those bonds you are probably going to feel it.
Remember bonds equal debt and there are a lot of companies, countries, municipalities in major debt trouble. It is a situation that has its D Day in the upcoming future.