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Bonds, which are debts sold by companies or government entities to investors to raise capital, are often offered by financial advisors and brokers as safe investments. But bond fraud can cost innocent investors substantial portions of their portfolios and retirement savings, and it is a problem that tends to increase amid recessions. Fixed income investments are supposed to be the cornerstone or foundation of a well-diversified portfolio. Your fixed income holdings are not supposed to be where an investor takes significant risk.
Types of Bonds
There are four general categories of bonds that are offered to investors:
There are different forms of bonds within these categories, and bonds may be purchased individually or through bond funds, in which investors buy into pools of bonds in a manner similar to mutual funds. High yield junk bonds have significantly more risk than investment grade bonds. In addition, junk bonds typically move up and down with stocks and provide little or no downside protection when the stock market is declining.
Examples of Bond Fraud
As with any investments, there are risks associated with bonds. Unfortunately, investors are not always made aware of the potential dangers by their financial advisors. The risks vary dramatically with different kinds of bonds and with different credit ratings.
In some circumstances, investors may buy so-called junk bonds, which are high-interest, high-risk corporate bonds. Junk bonds are often sold under the guise of bond funds or referred to as high-yield funds, and financial advisors and brokers have been fined for misrepresenting or omitting material information regarding the risks of the investment and the bonds themselves.
Different types of bonds come with varying inherent pitfalls, and your financial advisor has a responsibility to disclose all known material facts associated with a bond or bond fund offering and offer investments appropriate to your risk tolerance and other individual factors. Some bonds that promise high return, for example, may also be issued by a company that is a credit risk and may default; other bonds carry a risk that the issuers may be able to pay investors at lower interest rates and a reduced return; some bond funds may have been exposed to sub-prime loans.
Another common and particularly deceptive form of financial advisor misconduct is the concealing of charges related to the bond or bond fund. Because the prevailing market prices of many bonds are not available to investors, financial advisors sometimes exploit consumers by engaging in the practice of markups and markdowns. The markup is the difference between the actual cost of a bond and the fee at which it is sold to the investor; the markdown is the hidden fee subtracted from the initial purchase cost.
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