Investing can be tricky, even when it comes to so-called "safe" investments such as bonds. When a company issues a bond, the money they receive in return is a loan and must be repaid over time. Many investors choose bonds as long-term investments because they are supposed to guarantee returns on investment in addition to yearly interest income.
However, if you're investing in bonds, you should keep an eye out for these three major signs that it's time to sell right away.
1. Interest Rates Are Set to Rise
The most significant sell signal in the bond market is when interest rates are poised to rise significantly. Because the value of bonds on the open market depends largely on the coupon rates of other bonds, an interest rate increase means that current bonds – your bonds – will likely lose value. As newer bonds are issued with higher coupon rates reflecting the increased national rate, the market prices of older bonds with lower coupons will decrease to compensate new buyers for their relatively lower interest payments.
Pundits, analysts and anyone with a social media account can speculate about how and when the Federal Reserve will raise rates. If you sell your bonds as soon as someone hints at the word "hike," you may be jumping the gun. Instead, keep a close eye on announcements after the meetings of the Federal Open Market Committee (FOMC). The FOMC decides on the future of U.S. interest rates at these meetings, so take any definitive announcements from the FOMC seriously. When the market consensus is that a rate increase is right around the corner, it's time to go to market.
Unless you are set on holding your bonds until maturity despite the upcoming availability of more lucrative options, a looming interest rate hike should be a clear sell signal. There is one small caveat that applies to short-term holdings or those that are near maturity. If you hold bonds or other debt securities that have less than a year until maturity, interest rate risk is minimal, since your return on investment is so close and the coupon payments have been largely exhausted.
2. The Issuing Entity Seems Unstable
Another good reason to liquidate your bond holdings is if the issuing entity suddenly becomes financially unstable, suffers a huge loss that compromises its ability to remain profitable in the future, or becomes embroiled in legal issues. Since the appeal of bonds is that they generate guaranteed income, the credibility and solvency of the issuing entity is a primary concern. If the government or corporation that issued your bonds declares bankruptcy, for example, you are likely to recover only a portion of your investment.
Look into the financials of the companies or governments that issued your bonds on a regular basis – or make sure your financial advisor does – and seriously consider selling if it looks like they might be heading for a downward spiral. While you may recover some of your money if a bond issuer defaults, liquidating your holdings before the real trouble starts and reinvesting in a more secure product is a simpler and more sensible option.
3. The Market Price Is Unusually High
Like stock traders, active traders of bonds often look to technical indicators for buy and sell signals. To maximize returns, it is important to have set rules about how much profit you expect and how much of a loss you are willing to take. Though holding bonds until maturity can be moderately lucrative, you might be able to generate bigger gains by selling when the market value is high, especially if you've already held the bond for several years and have benefited from coupon payments.
By keeping an eye on the average market price of your bond over both short- and long-term periods, you can pinpoint moments when the price of your bond is highest and sell before it moves back down toward the mean. Like stock analysis, using an interactive charting tool makes this much easier. Look for moments when the short-term simple moving average (SMA) crosses up through the long-term SMA. This indicates that the current selling price for your bond has been consistently higher in recent days than it has been within your chosen long-term window.
Of course, you should always do a cost-benefit analysis before any trade. If the holding period return generated by selling now is equal to or greater than if you held it until maturity, it's probably time to sell.