Bonds, bonds, and even more bonds. In the investment landscape, bonds are very popular right now, but what are bonds and are they right for you?
What are bonds?
Bonds are a type of loan. If you have ever lent money to a friend, you should be able to understand the concept behind bonds. A bond is an IOU from an institution (government, corporation or other entity) to investors. For example, Company A might have a need for $5 million dollars. Instead of obtaining a loan from a bank, they instead obtain a loan from investors. This generally comes with a promise to pay back the amount at a specific time and at a specific interest rate.
Sounds simple, right? It really is a simple concept; however, you should note that because different bonds might have additional terms, it is important to read the details of each offer to ensure that it suits your financial goals. You should also seek advice from a licensed financial advisor since there are risks associated with buying a bond.
Key things to look for when deciding to invest in a bond instrument:
• Which company is issuing the bond? Investors should ensure they understand the business model of the issuing company. Do you understand how they generate revenues/sales? Are you comfortable with their revenue-generating activities and reassured that they can repay the loan? A key way to check this is to read the prospectus or terms of the bond offer and do your research on the issuing company. Be sure to check if the company and/or the bond has a good rating by a reputable rating agency (CariCris, Moody, S&P and Fitch rating agencies are a few popular ones). The closer the bond or company rating is to A, the greater the chance that the loan will be repaid.
• What is the bond's maturity date? Bonds have different maturity dates or dates that the company promises that they will return your investment. In other cases, there are bonds that go into perpetuity. In these instances, investors will not expect to get back their principal investment, but they will likely in turn get continued returns on their investment also into perpetuity. Be sure to review the terms with your licensed financial advisor to see if this is right for you.
• Returns on your investment: This will be expressed as the interest or expected yield on the amount you lent or invested. This yield may change based on demand and supply as with any other product. Especially in a high interest rate environment, such as what we are experiencing, bonds are increasingly offering higher interest rates than in previous years. This means that, while interest rates on bonds were in the single digits prior to 2022, we are increasingly seeing offers with double-digit interest rates, even on relatively short-term deals.
Additionally, you want to look at how frequently the interest is being paid. Some bonds pay interest at specific intervals over the life of the bond (eg quarterly) while others pay at the end of the life of the bond. It is up to you to determine what your preference is, based on your financial goals.
• Your ability to liquidate the bond before its maturity: Many investors may be concerned about what to do if they require access to their investment before the maturity date. This is where you need to ensure you are purchasing your bonds through an experienced broker who has the expertise and network to resell your bond on your behalf if you so desire. Secondly, the quality of the bond offer is going to be critical in getting it resold. Again, refer to the first point about the strength of the company or institution that issued the bond in the first instance, and also assess the size of the bond being issued.
Are they right for your portfolio?
Bonds may be right for you if you need to diversify your portfolio. With the stock market being a riskier investment tool, the more predictable nature of bonds allows you to add stability to your investment portfolio. The greater likelihood that you will receive your principal plus a defined return on investment at the end of the investment period allows you to add balance to your portfolio.
In addition, if you are interested in an investment that gives you a more predictable income, then bonds may be better for you. Remember we mentioned the periodic interest payment earlier? This allows you to plan around the expected receipt of your interest payment. So, whether you're treating yourself, your children, or reinvesting later, the greater predictability of interest payments makes it simpler to create a plan to meet your financial objectives.
So the next time a bond offer hits the market, I know that you will definitely feel more comfortable making an informed decision that aligns with your personal investment vision and goals.
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