While many investors are familiar with share investing, they might be less so with the bond market. A bond is a loan, where the bond issuer borrows money from the bond buyer.
To make it simple, bonds are usually set at a fixed amount of capital, with a set number of interest repayments over the life of the bond.
Consider a 10-year Treasury bond with a $100,000 face value, and a coupon rate (interest rate) of 3%.
Buying a bond
For buying this bond, an investor receives 3% ($3,000) every year, split over two payments, until the bond matures in 10 years. At maturity, the bond issuer (the government) needs to repay the face value — $100,000 in this example.
Because of their regular and reliable income flows, bonds are a popular investment product for income-focused investors. And because it’s usually governments and large corporations who issue bonds, they are often seen as safer than investing directly in shares.
But that doesn’t mean investing in bonds is without its risks. What would happen if you bought a bond with a fixed interest of 3% (for the life of the bond), and interest rates went to 5%? You’d rather own the bond paying a higher amount of interest (5%).
Although the interest payments of a bond are set, it doesn’t mean that the bond will hold its value. As interest rates go up, the value of a fixed-rate bond goes down — and vice versa.
Because investors could get a higher return with bonds issued at the higher rate, they’ll want to offload the lower income-producing bond. But the only way another investor would buy a bond with a lower rate is if they can buy it at a discount to its face value.
Unless they have large sums to invest, it’s unlikely that a retail investor will buy a bond directly.
However, there are several exchange traded funds (ETFs) that give you exposure to a range of different bonds. And because they’re listed on the ASX, you can adjust the size of your investment according to your needs, and enter and exit as you please.
If you think bonds might be of interest to you, please keep an eye on this page. We’ll post articles on how the bond market works, and show you how they can be a useful investment tool.