Recent turmoil in the financial markets may have you considering whether to sell or ride things out. If your portfolio contains individual bonds, you should factor in the liquidity of the bonds you hold when making that decision.
Liquidity describes the ease with which a security or other asset can be bought or sold in the market without a significant change in price. “Liquid” assets can be easily bought or sold and converted to cash. Some examples of liquid assets are foreign currencies, CD’s with maturities of 1 year or less, treasury bills, and money market accounts. Illiquid assets include such things as cars, houses, non-traded REITs, and insurance policies.
Bonds are generally considered to be liquid assets. The bond market, however, is not always instantly liquid. In addition, some bonds are easier to sell than others depending on current market conditions and the characteristics of the particular bond in question. You may face decreased liquidity and suffer investment losses if you sell a bond prior to its maturity while the financial markets are under stress.
In the case of stocks that trade on the NASDAQ, NYSE, or other exchange, your brokerage firm delivers the order to sell the stock to an exchange where a buy order is matched with the sell order. With bonds, if you place an order to sell your bond with your brokerage firm, it will typically offer to buy the bond from you at a stated priced, place it in its own inventory, and then find a buyer at a later date. Although, the financial crisis in 2007-2008 caused many bond dealers to reduce their exposure so they are not buying or holding as many bonds in their inventory as they did in the past.
Many bonds are purchased for the income they provide and are held to maturity. If you choose to sell your bonds prior to maturity, factors that may affect the liquidity of your bonds are:
Interest rates: When interest rates rise, bond prices fall. This can make it more difficult to sell the bond at a profitable price.
Bond variety: The large number of bonds – each with different characteristics – can make it difficult to match buyers with sellers. Bonds may be issued by corporations, municipalities, the U.S. Treasury and others; they may be foreign or domestic issues; they can have different maturities; and they can offer different interest rates.
Market volatility: During a period of economic stress in the financial markets, there are often more investors looking to sell, than there are looking to buy. And those that are interested in purchasing during a market downturn are usually seeking bargains. Most will not be willing to pay a price that the seller would be happy with.
Before you decide to sell a bond before it matures, you should discuss it with your investment professional. In addition, it pays to do your homework in advance. The Financial Industry Regulatory Authority (“FINRA”) provides pricing and other information about corporate and agency bonds, as well as, U.S. Treasury bonds through its TRACE Market Data Center. Information about municipal bonds (“munis”) can be accessed through the Municipal Securities Rulemaking Board (“MSRB’s”) EMMA website.