Many people who invest in bonds may have had quite a shock earlier this year when bond prices "headed south" due to renewed worries about interest rates and inflation. The decline of bond prices in such a short period underscores the potential risk involved in bond investing. For many bond investors, safety of principal is a primary objective, and the volatility recently shown by the bond market is a cause for concern.

Why do bond prices rise and fall? As a general rule, when interest rates climb, bond prices fall, and vice versa. If you purchase a 7% bond and, later, the interest rate on newly issued bonds of similar quality and maturity is 8%, your bond will likely fall in price in the market to a point where your 7% yield equals an 8% yield to a buyer of your bond.

Likewise, if interest rates on new bonds similar to your 7% bond fall -- say to 6% -- you could very well sell your bond on the market at a premium to its face value. So, the volatility of the bond market cuts two ways.

Note, though, that if you intend to hold your bonds to maturity, the interim price swings in the bond market have little impact on you. You will receive the face value of your bonds when they mature. The fluctuation of the bond market generally affects those investors who plan to sell before the maturity date, or who invest in bond funds that have no fixed maturity date.

Note, too, that the higher the quality of the bond and the shorter its maturity, the more likely the bond's price will remain relatively stable in times of rising interest rates. For example, Treasury obligations usually fluctuate less than lower-rated corporate bonds.

Bonds have traditionally been considered a "conservative" investment. And, properly managed, a portfolio of bonds can provide a relatively stable income while generally preserving capital. But bond prices can fluctuate to a surprising degree in certain economic environments. Professional assistance, therefore, is more important than ever for the bond investor.

Emily S Hazlett is Vice-President:Investments at ENB Insurance Agency, Inc. a wholly owned subsidiary of Evans National Bank.