The Corporate Bond Wars: Interest Rate Risk

Here is Larry Denham opinion about Interest Rate Risk. He gives the advantage to Individual bondholders.

Bond Funds: Because bonds in a bond fund are constantly being bought and sold, there is no specific maturity date for the money invested in the bond fund. Like all fixed income investments, the money held in the bond fund is subject to interest rate risk (an inverse relationship exists: when interest rates increase bond prices decrease and vice versa). Hence, when shares are liquidated they are sold at the current net asset value (NAV); and, depending on interest rate levels, the sale could result in a potential loss of principal. Generally, the risk of price volatility and fluctuating principal is higher for bonds with longer maturities.

Individual Bonds: Individual bonds have a defined maturity date. Interest rate risk is avoided by purchasing individual bonds with the intention of holding them to maturity. The market price of any fixed income investment fluctuates prior to maturity based upon the level and direction of interest rates. As a result, barring a credit default, if a bond is held to maturity it provides principal protection by being redeemed at par value, regardless of prevailing interest rates.

In my opinion, this is the basic problem with bond funds, no maturity. That leads to the Investor being at the mercy of the fluctuations in inflation and interest rates. With individual bonds, the shorter the maturity, the less likely you will be affected by interest rate risk. If you keep the bonds to maturity, the investor is only affected in an “out of control hyper inflationary cycle”. In most cases, the bond holder is not affected at all.