Be wary of buying short term bonds in 2020

Short term bonds are those that are issued for 5 years or less and they are generally considered to be lower risk than longer term alternatives. Some of them are even issued for a period as short as a year.

This is an option that is worth considering if you want to keep risk levels low and also retain flexibility in your investments. What is the situation with them like in 2020, though?

Consider when they will gain or lose value

Short term bonds will lose value when interest rates rise. It is worth bearing in mind that longer term bonds will usually give a higher return than a short term equivalent. However, this is because they carry a greater risk of losing value if interest rates are pushed up.

If the interest rate goes up, you could end up with a bond that pays lower than the market rate. The longer the term, the greater the risk of receiving a poor return for more time.

Inflation is another factor to take into account. If this rate increases, the interest paid on a bond is worth less. Again, the shorter the term, the lower the risk of receiving a poor return.

The current economic climate

As we have seen, short term bonds are a safer bet when you think that interest rates and inflation will rise. At the moment, the exact opposite looks like happening though, as they have fallen and could carry on doing so.

In fact, it was recently reported that short-term UK bonds dipped below zero for the first time because of this issue. This means that if you invest in bonds like this, you will lose money instead of making it. Investors are essentially giving the government money for borrowing with bonds.  

Right now, there is also a chance that UK rates are cut again. The Bank of England just cut them a few days ago, from 0.75% to 0.25%. However, there is talk of another cut being considered right now.

Negative interest rates have been ruled out by the BoE in the past but with the current crisis anything goes. With the current rate at 0.25%, there is very little leeway for them to cut any more without veering into negative numbers.

We are in uncharted territory right now. Opting for the safety of buying bonds isn’t a bad idea in itself. But choosing with a short maturity term could see you losing money instead of earning it.

What should you do?

Short term bonds are a poor choice just now. With interest rates so low and expected to fall further, their return is already in negative figures.

However, it is worth keeping an eye on interest rates and inflation later this year. If these numbers start to rise, short term bonds could become more attractive than longer term options. Of course, with the financial turmoil currently taking place, the security of a government-backed bond remains one of the safest types of investment.