Should You Avoid Callable Bonds?

Callable bonds, sometimes also called “redeemable bonds” are a potentially risky investment, since the company can call back, or pay the bond, before the maturity date. If the company chooses to pay, investors may not get the full return on their investment. If the bonds are not called, however, investors earn the amount of money they thought they would, which means they are no different than any other bond type. Despite their risk, callable bonds are a popular type of bond to purchase, simply because they do not cost as much as a straight bond, and the yield on the callable bond is generally higher than it is on a straight bond. 

The Terms and Conditions of Callable Bonds

When someone decides to purchase a callable bond, there will be terms and conditions that must be agreed to before the bond can be purchased. These terms and conditions will set forth the guidelines that must be met before the bond can be redeemed. There will also be a call date which specifies the earliest date the issuer can demand payment before the bond reaches full maturity. As the terms and conditions will vary from bond to bond, it is essential that all potential buyers read and understand all the terms and conditions before signing the agreement and purchasing the bond.

Why Choose a Callable Bond

Even though they are considered risky because they can be called before their time, many investors still use this type of bond because they are issued at a higher coupon rate--the interest paid per year on a bond as a percentage of the total bond amount--than straight bonds. This means that a 20 year callable bond is called at the 10 year point, it will still more than likely earn more than a 20 year straight bond because of the difference in coupon rates.

Should You Avoid Callable Bonds?

While we wish there was a more clear answer, unfortunately, there is not a clear “yes” or “no” we can present here. As there are risks and benefits associated with a callable bond, and nearly everything else we encounter in life, it is up to the individual to weigh them and decide what to do. While there are some people who swear against a callable bond, there will be others that swear by them.

Depending on your financial situation and goals, this bond option may be perfect for you. If you are having trouble deciding what to do, consult with a professional financial advisor to see what the best course of action would be. One option would be to invest in several different bonds of all types, so you can experience each type of investment for yourself and then decide what to do.

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