The Risks of Short Term Bonds

The risks of short-term bonds tend to be very different from those that affect longer-term bonds. Because your money is at risk for a far shorter period of time, default risk is largely reduced. While it is often difficult to calculate the probability that a company will default over the next 30 years, you can feel more confident that it will last for the next six months.

The biggest risk you face by investing in short-term bonds is reinvestment risk. While a short-term bond does not tie up your capital for an extended period, it also does not lock in a given interest rate. If you buy a short-term bond today, with the hopes that rates will be stable or higher in the future, and then rates fall, your next opportunity to deploy that capital will be at a lower rate.

Most bond investors look for a balance between locking in for a longer-period (higher default risk), and guessing where rates will be in the near-term (reinvestment risk). There are a variety of portfolio construction techniques that you can use to address these issues, but understanding the risks is an important first step. Short-term bonds still carry some default risk, even though this is not the primary risk focus.

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