There are over 17 trillion dollars of bonds with negative yields. Does this mean you are paying someone for the privilege of loaning them money? And why are people buying them?

Monday Morning Money—Bonds With Negative Yields

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$17 Trillion of Bonds With Negative Yields

There has been a lot of attention lately about the more than $17 trillion of debt with negative yields. Much of that is issued by foreign governments. But there is about a trillion dollars in corporate debt with negative yields
 
So does this mean you are paying these countries for the privilege to loan them money?

The Basics of Yield

Yield is the return you will earn if you buy and hold a bond until it matures. It factors in the interest rate, the return of your principal, how long until it matures, and the price you pay.
 
So keep in mind, yields and interest rates are NOT the same thing. In some cases, these bonds could pay the investor interest. German bonds currently do not. But you can have a bond with a negative yield which does pay interest.
 
The thing which causes their yields to be negative is the price investors have to pay. Paying a high price and holding the bond to maturity assures you of a negative return—even though you might collect interest along the way.
 
Let’s look at a simple example. You have a bond which matures 10 years from now. It has a coupon or interest payment of 1.6% per year. You collect that for the life of the bond. When the bond matures, the issuer typically redeems them at a price of $100. If you buy this bond for a price of $116 or more, your yield will be negative. Why? Because the return from your interest won’t be enough to compensate for the high price you have to pay.

Why Buy Bonds With Negative Yields?

This is where it helps to understand the relationship between yield and bond prices. Yields and prices are inversely related. That means if one goes up, the other goes down. Think about a teeter totter. On one end you have prices, the other side yields.
So why would someone buy bonds with negative yields? If you know you are going to lose money holding these notes, why wouldn’t you just put the money under your mattress?
 
One theory is speculation.  Those who are buying these notes are speculating that yields will go even lower. That’s the only way buying a bond with a negative yield results in a profit.
  
Those who are buying these notes are speculating that yields will go even lower. That’s the only way buying a bond with a negative yield results in a profit.

Buy Low, Sell High

There is a saying in the investment world. Buy low, sell high. With bond yields at extremely low—and in some cases negative—levels, it means prices are already high. Buying bonds with negative yields, or longer term bonds with very low yields, seems like a recipe for the opposite.
 

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Financial Planning

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors  He typically works with people who are planning for retirement.  Fleming Watson is a Registered Investment Advisory firm located in Marietta Ohio.  Our firm primarily serves Marietta, Parkersburg, Williamstown, St. Marys, Belpre, Vienna and the surrounding communities in Washington and Noble Counties in Ohio and Wood and Pleasants county in West Virginia.

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