Why Longer Term Bond Yields are Higher

Although bonds are often a safer investment option than many stocks, there are still risks involved. Those who invest in bonds purchase them based on maturity and the yield they are going to earn until maturity. Short-term bonds typically earn lower rates of return simply because the investment must be returned to the investor in less time. This means the issuer can use the funds for short-term projects only.

Bond issuer perspective

When a bond is issued to fund a specific project such as a water, sewer or school project, these bonds are often issued with longer maturities. Not all investors are willing to tie their funds up for longer periods of time without being guaranteed a specific return. This means that in order to attract investors, the decision is often made to pay a higher rate of return.

Bond purchaser perspective

Although current interest rates are low, investors still have many investment options. Younger investors are often willing to take bigger risks on liquid investments. Bonds are generally considered a long-term investment and therefore may not be as “exciting” an option for these investors. However, those who are seeking safe investments may want to consider bond purchases. Generally, bond issuers are backed by the full faith and credit of the issuer and are much less risky than stock investments.

Short-term less benefit

The less time that an investor is willing to risk their money, the less benefit they will obtain from that investment. Bond issuers guarantee to the bond holder not only payment of the face value of their bonds, but also periodic fixed payments on those bonds (e.g., interest payments). The less time that the bond is outstanding, the less likely the issuer is to have financial problems that can result in their not meeting their obligations.

Long-term bond risks

While many people think that bonds are issued only by state governments or the federal government, many companies issue bonds as well. The bonds are backed by the full faith and credit of the company, but longer-term bonds such as 3 year, 5 year or more are far riskier, not only for the investor, but for the company. For the investor, they are offered no guarantee that a company will have the liquid assets to meet their obligations to bond holders. From a company perspective, they understand that when the long-term bonds come due, they must either pay investors the face value of the bonds from available cash or, liquidate assets to meet the obligation.

While bonds are a more stable investment in most cases than stocks, there are still risks associated with investing in bonds. The longer an investor is willing to risk their capital, the more a bond issuer is willing to pay them for accepting that risk. Market factors play a role in availability of capital; bond issuers know investors have other options which is one of the reasons why longer-term bond yields are higher than short-term bonds.