The Bond Market: Should You Be Interested?Sunday, June 20, 2021
Much is usually made about the stock market, and for potential investors seeking investment opportunities, this is usually a good option. Investing in stocks, or shares of companies, is an excellent way to grow wealth, especially for long-term investors, even during periods of market volatility. But there are other investment solutions available; the bond market being one. It's a great way for both the individual and corporate investor to make their hard-earned money grow for them. But so many people, even seasoned investors, are strangely ambivalent or downright ignorant about this market, confused by what they perceive as the complexity of the market compared to the stock market. The truth is, bonds aren't that complicated, they are arguably even easier to understand when compared to the stock market and its indicators, indexes, exchanges, etc.
What are they?
Bonds are secured or unsecured investments that are good for meeting medium- to long-term goals, often attractive to income investors. When you decide to invest in a bond, you are lending money to the Government or a company, for a specified period of time, rather than acquiring shares in either of those entities, as you'd do with a stock investment. Hence, where bonds are concerned, you are the lender and where stocks are concerned you are an owner. Bonds give you no ownership rights. They are issued by these entities when they want to raise capital and finance operations and don't want to go the bank loan route. By buying a bond, which is available in all major currencies, you're giving the issuer a loan, and they in turn agree to pay you back the face value or principal of the loan on a specific date, while paying you periodic interest payments.
Popular types of bonds in Jamaica
Government issued bonds (local or global) — Good when contemplating medium- to long-term goals like buying a car or a house. They offer a set interest rate paid every three or six months, providing a steady income stream with a minimum investment specific to the bond being issued.
USD Indexed Bonds — Ideal for mid-range or large investors who seek competitive rates of return on their investments while hedging against devaluation of the local currency. The USD Indexed Bond offers a fixed rate secured investment for the short to mid-term of 3 to 5 years. Global or local corporate bonds — Also provide investors with a steady way to earn income with scheduled interest payments throughout the tenor of their investment with the bonus being that they tend to be denominated in hard currency, providing protection from any depreciation, with interest payments made semi-annually.
Can't I just stick to stocks?
Financial advisors usually advocate that investors invest a portion of their portfolio in bonds because of their lower volatility when compared to stocks; ie they tend to be relatively safer in comparison to stocks.
Let's say you've only just begun to build your investment portfolio. You've bought some stocks. But that's about all, because you're a risk-averse investor, prone to getting the jitters when there's any kind of volatility in the market. But you know you need to invest more in order to meet your future goals. However, you can't help but worrying that there could be a stock market crash in the not-too-distant future. Didn't the sudden onslaught of COVID teach you that anything can happen at any time? What would happen to your money in such a scenario?
What you need is a strengthening of your risk-return profile. What's risk-return? The risk-return principle posits that potential return rises with an increase in risk. Invested money will normally yield higher profits but the investor has to be willing to accept that there will be a higher possibility of loss. Adding bonds is a good way to shore up risk-return, by providing diversification and balance to your portfolio.
So, should I buy bonds?
Every investment has some risk associated with it. But the solution is to have a diversified investment portfolio so you can mix high levels of risk with low ones, in this case bonds, thereby lowering your exposure and providing a bulwark, so to speak, against stock market or even real estate crashes. Let us say there was volatility in the market that affected your stocks, well-positioned bonds in your portfolio, which have lower volatility and as such are usually lower-risk, would offset some of the volatility you might see from owning stocks, by providing balance. Bonds allow you to earn competitive rates of return while hedging against devaluation. Another benefit is that publicly traded bonds are liquid. Further, they provide an additional stream of income, by way of fixed interest or coupon payments, in addition to a lump sum at the maturity date. Bonds like stocks can lose value; some bonds are risker than others. In the event that an issuer cannot pay back the money the bond will go into default. Market volatility could also impact your capital gains negatively or positively, capital gains being the difference between the price you purchased the bond and the price you sold the bond at. Investors typically forego higher potential gains associated with investing in the stock market. Perhaps one of the biggest challenges to investors is the barrier to entry. Bonds tend to require a higher initial capital investment than stocks.
A bond investment is an asset that requires a fixed payment to the holder, usually with interest. The market is driven by the same risk-return trade-offs as the stock market, and just like stocks, can be a good addition to your investment portfolio.
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