Fixed-income investors often focus on how much an investment could earn while giving less attention to what they might lose if things go wrong. Three mistakes can leave even experienced investors exposed: concentrating too much in one issuer, choosing bonds solely for their returns and confusing an issuer’s reliability with whether an investment fits their needs.
The first mistake is excessive concentration. A traditional debt security held to maturity offers the return set by its terms, but a default can put a substantial portion of the principal at risk. Unlike a stock that could rise dramatically, a fixed-income investment generally does not offer an equivalent prospect of extraordinary gains to offset a major loss.
For example, a R$1 million investment in a bond paying 15% a year would generate R$150,000 in interest during the first year. A 50% loss of principal, however, would amount to R$500,000. If the money were divided equally among 20 independent issuers, a 50% loss at one issuer would reduce the overall portfolio by 2.5%. The article recommends spreading investments across issuers and avoiding allocations above 3% to any one issuer. Fixed-income funds can help mitigate this risk through diversification.
The second mistake is selecting a bond simply because it offers the highest yield. A bond paying 120% of the CDI may look more attractive than one paying 105%, but the difference could reflect greater credit risk, lower liquidity or less favorable terms. Diversification can limit the impact of a default, while assessing the additional return helps investors decide whether the risk is worthwhile.
A comparison between bonds paying 12% and 15% a year illustrates the trade-off: the extra three percentage points may seem appealing, but a 30% loss of capital would equal ten times the additional first-year return. Investors need to consider not only what they could earn, but also how much they could lose and the likelihood of that loss.
The third mistake is assuming that a reliable issuer automatically makes an investment suitable. Someone who buys a long-term Tesouro IPCA+ bond to fund a property purchase in two years could face a significant loss if interest rates rise and they have to sell early, even if there is no default.
Other mismatches can also undermine a plan. Inflation may erode the purchasing power of returns from a fixed-rate bond, while an investor relying on CDI-linked returns could find that income falls after a reduction in the Selic rate. The relevant risk is not only failing to receive payment; it is also not having the amount needed, under the right conditions, when the money is required.
These mistakes can compound: an investor drawn to a high rate may concentrate money in a bond that does not match their goals. Diversifying, seeking compensation that reflects the risk and aligning investments with their time horizon can help protect capital, even if they do not produce the highest possible return.
Sources: Folha Mercado.