If you are going to invest in corporate bonds, realize that recognizing names is not good enough and can get you into trouble.
I recently received a question from a reader worried about holding on to bonds issued by Bear Stearns just weeks before the bailout.
She had bought the bonds due to mature in March 2010 at 5.3 percent for $75,000. Recently her broker told her they were worth only $68,000.
She is wondering now if JPMorgan Chase will honor the maturity if the proposed takeover goes through.
JPMorgan has said it will assume Bear Stearns’ obligations once the acquisition is complete. When that happens, it will be as though the buyer purchased JPMorgan bonds, not Bear Stearns bonds.
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That should give this reader comfort. Although no corporate bond is as safe as a U.S. Treasury bond or an FDIC-insured bank CD, her bonds will be significantly safer than they were.
Instead of a bond in a company teetering on the verge of bankruptcy, she will have a bond backed by one of the nation’s strongest financial institutions — one with a Moody’s rating of Aaa3 for bonds such as hers. That’s a strong rating.
Of course, investors lately have come to realize that strong ratings aren’t always dependable. After all, Standard & Poor’s was rating Bear Stearns bonds AA when the company was on the verge of bankruptcy in March.
But typically ratings of A and above are a better sign than if you see B’s or C’s in bond ratings. If you see corporate bonds rated below A, you should assume there is a strong risk that the company could have trouble paying you what you expect.
For a simple-to-read list of bond ratings see: “What Do Bond Ratings Mean?” at www.aarp.org/money/financial_planning/sessionsix/bonds.html.
Learning about risks in bonds is critical if you want to safeguard your money. Although the rescue of Bear Stearns has made your existing bonds more secure, you should make sure you don’t take chances again.
If you truly cannot afford to lose money, avoid corporate bonds and stick with safer choices: U.S. Treasury bonds, CDs, general obligation municipal bonds. To find the best rates on CDs, search Bankrate.com.
Some investors don’t like safe bond choices like Treasurys because interest rates are low. But as you have discovered, there is a reason corporate bonds pay more interest: They are riskier.
And they pay investors a percent or more than safer bonds to entice people to take a chance on losing money.
When you see a bond paying 2 percent more than a Treasury, instead of hoping for the best, you should say to yourself: “That’s a red-flag warning me about the risks I am taking.”
Too often investors hear powerful names like “Bear Stearns” or “Enron” and decide a bond is safe. If you are going to invest in corporate bonds, realize that recognizing names is not good enough and can get you into trouble. Such household names as Kmart and United Airlines have experienced bankruptcy.
3 ways to lose money
When investors buy corporate bonds of weak companies, the investors can lose money three ways, especially if a company goes into bankruptcy or becomes weaker than previously thought.
The company might stop paying you interest. Or it might not be able to return your principal, which is your original investment.
But even if conditions aren’t that dour, there is a third way to lose.
You received a taste of this when your broker told you that you could no longer get your full $75,000 back if you tried to sell your bonds for peace of mind. He told you to expect just $68,000. In other words, at that price you would lose $7,000.
Bonds drop in price whenever investors become concerned that a company might not be as strong as it once was. As a company’s finances weaken, the chances increase that the company will “default” on bond payments, or not pay investors back what they are expecting. The price drops because a riskier bond isn’t worth full price.
Looking at prices can be a more reliable clue about the risks in your bonds than the bond ratings. For example, your bonds now appear to be worth about $72,330 — not your original $75,000, but certainly better than the $68,000 your broker quoted a few weeks ago.
The improved price suggests investors are feeling fairly certain now that JPMorgan will finish the acquisition of Bear Stearns.
You should be aware that prices in bonds aren’t as concrete as you might think. They can vary based on how investors are viewing prospects. They also can vary between brokers on a single day based on the commissions brokers charge.
If you want to make sure you are getting a reasonable price on a bond from a broker, or you want to see what the market is saying about the value of your bonds, there is a Web site to check: Bondinfo.com.
At the site, click on “bonds” on the left side, and then click “corporate.” In the box that says “symbol,” write in the CUSIP number that is on your bond. Then hit “search.”
As an example, I used the CUSIP 07387EHY6 for a Bear Stearns bond. You will see the price of the bond was recently lower than the original, but not down much. See 96.442. That’s 96.442 percent of the original price. To see what your loss would be, assume your $75,000 original investment and multiply by 0.96442.
If you sold the bonds now at the 96.442, you would receive about $72,330.