The Buy-and-Hold approach saves money by investing in a combination of short-term and long-term bonds allowing investors to reinvest when the bonds mature and take advantage of market opportunities, while the longer-term bond offers a more attractive interest rate. Older bonds carry interest for up to 30 years after the issue date, so you get more money back at face value. If you can cash out savings and invest in a better investment, you deserve a higher return.
When you buy a bond, you lend it to the issuer, which can be a government, a municipality or a company. The borrower issues the bond to raise money from investors who are willing to lend to them for a certain period of time.
Each bond is subject to its own interest rate, which depends on supply and demand. The interest rate is the rate of return an investor needs to invest in a bond. The interest rate on a bond fluctuates with market views and is adjusted to new economic data such as inflation, the credit rating and maturity date of bonds as well as the widely used interest rates of central banks.
Interest is paid when rates are low: standard EE bonds pay 0.1 per cent with no interest adjustments. Series A bonds (inflation-protected savings bonds) pay a combination of fixed interest rate (0%) and semi-annual inflation rate (recession in percentage terms) that results in regular interest rate increases (e.g. Unlike Treasury bills and bonds, Treasury bills are not subject to interest, i.e. Sold at a discount.
If the bond is held until maturity, investors will receive face value plus interest. At maturity, the bond will be worth more or less than its par value. It’s perhaps the opposite of cashing in on casino rewards.
In the short term, falling interest rates increase the value of a bond portfolio, while rising interest rates hurt its value. Falling interest rates also mean that older bonds pay higher interest rates than newer ones and therefore tend to be sold at a premium on the secondary market.
In a falling interest rate environment, money in maturing bonds may have to be reinvested into new bonds that pay a lower interest rate, lowering the long-term yields. Over the long term, rising interest rates can increase the yield on a bond portfolio by reinvesting money in maturing bonds into higher-yielding bonds. Rising interest rates make newly issued bonds more attractive to investors because they have a higher interest rate than older bonds.
Remember that rising interest rates mean higher future returns for bond investors because your fund manager can sell the old ones and buy the new ones. Their interest payments will be reinvested and the fund manager will buy new bonds at a lower price as interest rates rise. Looking at current market conditions, Harmon says there is no good reason to buy long-term savings bonds as collateral because they are not very attractive because they offer a low yield compared to other investments.
As a general rule of thumb, inflation drastically reduces the interest that you earn on an investment such as a savings bond which erodes wealth over time. The way to combat this is to have a range of bonds whose interest payments change with inflation, which protects your money from longer periods of inflation.