AS investors flock to stocks a seasoned trading expert reveals why bonds — the humble yet robust workhorse of the financial world — deserve a closer look.

Andre Reid, senior trader at JMMB, warns that overlooking bonds could be costing investors thousands. In an exclusive interview with the Jamaica Observer he explained why bonds are the smart investor’s secret weapon.

“The price [of the stock market] has actually been going down over the last couple of years. And if the company does not pay a dividend, you don’t necessarily get a return. Bonds, whether or not the price goes up, as long as the company is in operation and in good financial health, you will get your interest,” Reid shared.

Despite bonds being more secure, many investors shy away from the asset class, and Reid believes it’s mainly due to a lack of education on how bonds work and the fact that they are not as widely marketed as stocks. According to
Investopedia, bonds are a type of fixed-income investment in which an investor loans money to an entity (typically a corporation or government) for a defined period at a fixed interest rate. In essence, bonds are debt securities that represent a borrower’s obligation to repay the principal amount with interest.

In breaking down the explanation further, Reid used a scenario with a business seeking to expand its operations and turns to bond financing to raise the necessary capital. With the goal of purchasing a new property the business requires $10 million but lacks the funds upfront. To bridge this financial gap the business approaches six investors with a proposal: In exchange for the $10 million loan the business agrees to pay an annual interest rate of five per cent, split into two semi-annual payments of 2.5 per cent every six months. Additionally, the business commits to repaying the initial $10 million borrowed at the end of the 10-year bond maturity period. One of the significant advantages of bonds is their specific repayment dates, which provide clarity and predictability for companies.

“In most cases, bonds are secured, whereas with a stock, stocks are not secured. In the event that a company or an issuer is supposed to go into default, bondholders are generally repaid before stockholders,” said Reid.

He revealed that some people probably might own bonds without even realising because a certificate of deposit (CD) from the Bank of Jamaica (BOJ) is a type of bond.

“Some people own it; it has a maturity date; you know the issuer is BOJ; it also pays interest or a coupon; and it is actually tradable, meaning that you can sell it from one person to another,” he explained to Sunday Finance.

In giving an assessment of the investment scene locally, Reid expressed that over the last few years interest rates have been getting higher and the stock market is underperforming. As a result, more people are moving towards the “safer asset class”. He further explained that when interest rates are higher, bonds are more attractive because stocks actually have an inverse relationship. So when interest rates are high, people will do more bond trading than stocks.

For the most part, he says those who participate in bonds are usually your “sophisticated investor”. The minimum investment required for bonds can be prohibitively high, ranging from $1 million to US$200,000. However, some institutions are willing to break these bonds into smaller amounts in unit trusts, depending on the relationship with the financial institution.

Despite these challenges, Reid believes that bonds can play a vital role in a diversified portfolio. However the complexities of bonds, including how prices move and the implications of investing, can be overwhelming for novice investors.

“I don’t believe that it is something that your first-time or starting-out investor understands and wants to appreciate as the first part of their portfolio,” he noted.

Emphasising the importance of portfolio construction, particularly for younger investors who may be more risk-tolerant, he pointed out that many new investors are putting their entire portfolio at risk.

“If you really think about it, you know you have $10 million, you wouldn’t be prudent to have all of that $10 million in a single stock, or overall, in the stock market at all,” Reid warned.

He advised younger investors to spread their investments across different asset classes to reduce risk and potentially earn greater returns. By diversifying their portfolio investors can mitigate the impact of market fluctuations and make informed decisions about their investments. He also noted that younger investors tend to be more risk-tolerant, making stocks a more attractive option. However, this approach can lead to exposure to too much of a particular asset class or even a single asset. By understanding the inverse relationship between stocks and bonds, particularly when interest rates rise, investors can make informed decisions and potentially earn greater returns.

And according to Reid, in the sense that interest rates are believed largely to be somewhere near their peak, now is the best time to invest in bonds. He explained that most people expect that interest rates are supposed to be going down in the near future.

“So if the relationship is true that when interest rates fall and prices go up, then yes, now would be a good time to be considering bonds,” said Reid.