To sell or not to sell - that is the question

Interest rates are low and have been for quite some time, so it may be hard to remember a time when you could buy an investment grade bond with a coupon of 8.0 percent, but that was once the reality.

If you are a lucky investor who is holding such a bond, you may have noticed that as interest rates declined the price of your bond probably began to rise. This is because there is an inverse relationship between interest rates and bond values. You are now holding a precious asset that everyone covets, because gone (at least for now) are those lovely bonds paying those high coupon rates, and as a result people are willing to pay a premium for your bond.

The holder of a bond that has increased in value has the option of selling the bond before maturity and realising a capital gain. A capital gain is a profit that results from the sale of a capital asset, such as a bond, stock, or real estate, where the sale price exceeds the purchase price. Conversely, a capital loss arises if the proceeds from the sale of a capital asset are less than the purchase price.

When faced with an opportunity to make a capital gain it is only natural to wonder if you should sell your bond. Some of the questions an investor should ask themselves when this opportunity comes knocking are:

"If I decide to sell, what will I do with the proceeds of the sale?"

"How much future income am I foregoing by selling this bond?"

When looking at reinvestment options, bear in mind that if the price of your bond increased due to a decline in interest rates it is likely that other bonds of similar credit quality offering a similar coupon rate would have also risen in price. Additionally, newer bonds that have come to the market would offer lower coupon rates in keeping with the current low interest rate environment. 

As a result, you may have to reinvest the proceeds in a higher risk bond to get the same or better returns than you were earning on the bond you sold or be willing to accept a lower yield if you reinvest in a bond with a similar risk rating to what you had before.

If you are considering selling your bond before maturity to realize capital gains, the key is to do the math. The gains you make may or may not be high enough to compensate for any foregone future interest income or having to replace the bond with one paying a lower coupon.

Toni-Ann Neita-Elliott, CFP is the Vice President, Sales & Marketing at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm   

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