6 Potential Downsides to Buying Individual Bonds

Stocks & Bonds

6 Potential Downsides to Buying Individual Bonds

Bypassing funds and going directly into the market has benefits, but isn't without risk.


We've outlined the reasons holding individual bonds (rather than bond funds) can give investors greater certainty in their return and costs — and how to deal with the nuts and bolts of buying issues. But buying bonds directly is not without risk. Here are six hazards to consider:

See Graphic: How to Read a Bond Listing

Default. Unless you buy only U.S. government–backed debt, you face the risk that a bond’s issuer could default on its obligations. The best defense is diversification. If you own high-quality bonds, you should hold securities from at least 10 issuers; if you own triple-B-rated bonds, up the number to 20. If you dabble in junk bonds, hold even more—or, better yet, invest through a mutual or exchange-traded fund.

Rising interest rates. Bond prices normally fall when interest rates rise. But if you keep a bond until it matures and the issuer repays the principal in full and on time, that shouldn’t be a problem unless inflation is surging.

Call. If you buy a bond that’s callable, the issuer may force you to redeem the bond early, typically at face value. If you paid more than face value, you will forfeit that premium when the bond is redeemed.


Downgrade. The price of a bond is almost certain to drop if a rating agency downgrades its assessment of the issuer. Again, if you hold to maturity and the issuer pays you back on time, that isn’t a problem.

Liquidity. Bonds don’t trade as smoothly as stocks do, so spreads between bid and asked prices tend to be wider than for stocks. Also, if you need to sell a bond, there may not be a bevy of buyers, so your broker is likely to offer you appreciably less than you think the bond is worth.

See Also: Best Income Investments Other Than Dividend Stocks