Ric Edelman: Today we're talking about risks that can affect your bonds. Today's topic, Credit Risk. Almost all bonds have a credit rating. This rating estimates the safety of the bonds. Will you get the interest you're promised, will you get your money back at maturity?
The credit rating helps you know how safe your bond is. Naturally, investors are willing to pay more for bonds with high ratings and less for bonds with low ratings.
But bond ratings can change, say, if a company or state government gets into financial trouble, if that happens, the bonds they have already issued, the bonds you have already bought, could get downgraded, and if they get downgraded, you could lose 10%, 20%, even 30% or more from your bond's value.
And if interest rates rise 3% on a 7 year duration bond while this is happening, your total losses could be 30%, 40%, even 50%, and you bought bonds because you thought they were safe.
Well, that's not exactly the safety you were looking for, is it?