Every investment carries some level of risk. Investing in bonds involves two main types of risk. The first is inflation, where the value of the money you invested becomes worth less than when you invested; so a dollar invested today is worth two dollars on paper years later but has a value equal only to your original dollar. The second is a credit risk where the institution whose bond you bought files for bankruptcy. In this case, you lose everything because a bond is debt to the company and under bankruptcy, the institution cleans its slate of all debt.

Create a Ladder

To minimize your risk, create a bond ladder. Because there are 12 months in a year, you want to divide the amount of money you want to invest in bonds into six chunks. Pick bonds that have different interest payment months. For example, one bond might have payments in January and July. Another might have a payments in February and August. By splitting up your funds into six chunks, you can get new bonds every year and after six years have payments coming in once a month. You want to purchase bonds that have different maturing dates. Get bonds that mature in one year to get money faster, but then turn that money around and purchase bonds that take longer to mature. Do this is because those bonds have a higher rate of return on your investment. To protect against lowering interest rates, purchase bonds with a fixed interest rate. If you purchase it at 5% and the general interest rate on new debt drops to 3%, your interest rate remains at 5%. The most important detail of a bond ladder is that you need to continue taking the revenue that you bring in and reinvesting it in more bonds. This way, you have bonds that are paying interest out each month and, more importantly, are continuing to buy more bonds that will mature at different times. You also want to have short term bonds at all times to ensure that you have money available in case something happens such as an economic crisis where you want to have liquid cash on hand.

Source:

Types of Risk Investing in Bonds

Build a Bond Ladder