Deciding on a Bond Maturity Date
Bond yields typically increase as maturity date lengthens, since more risk is assumed when holding a bond for a longer time. When interest rates are low, it is tempting to lock in higher yields by selecting bonds with longer maturity dates. However, use that strategy with care. If you purchase a long-term bond knowing you'll need to sell it before maturity, interest rate changes can significantly affect your bond's market value. Two fundamental concepts about bond investing apply:
- Interest rates and bond prices move in opposite directions. A bond's price rises when interest rates fall and declines when interest rates rise. That is because the price of an existing bond changes to provide the same yield to maturity as an equivalent, newly-issued bond paying prevailing interest rates. You can eliminate the effects of interest rate changes by holding the bond to maturity, when you receive the full principal value.
- Bonds with longer maturities are more significantly affected by interest rate changes. Since long-term bonds have a longer stream of interest payments that do not match current interest rates, the bond's price must change more to compensate for the interest rate changes.
Although you can't control interest rate changes, you can limit the effects of those changes by selecting bonds with maturity dates close to when your principal is needed.
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