When you invest in bonds, you are lending money to the government or a company at a fixed rate of interest. One way to think about bonds is like an I.O.U that includes details of how much is owed and when it will be paid back. Bonds are used by companies and governments to be able to finance projects or operations. The details of a bond often include when the full amount of the loan will be paid back to the bond owner, and how much interest will be paid incrementally.
Bonds are considered to be a “safe” or defensive form of investment. This means that the returns on your investments aren’t likely to be as high as what you might expect from investing in shares, but you can expect more stability. This is why bonds could make a strategic asset for your portfolio, especially in periods of volatility or falling interest rates.
What are bonds and how to invest in them?
When investors buy bonds they are loaning their money to companies or governments who will pay regular interest and after an agreed amount of time reimburse investors their full loan amount – similar to an interest-only loan. Regular interest payments can provide a steady income and bonds can also help create a diversified portfolio, making bonds an attractive investment for some.
Types of bonds
Before you get started investing in bonds, it is important to know the different types of bonds in Australia and which may be more suitable for you. The two main types are Corporate and Government bonds.
- Corporate bonds – These are normally a part of a public offer when a prospectus is issued by the company and investors can buy directly. The difference between buying shares and investing in a bond is that you do not own part of the business and your investment is not impacted by the cash flow of the business. Your return is restricted to the principal amount you invested and any interest payments that were agreed on.
- Government bonds – The Australian Government issues Commonwealth Government Securities (CGS) that can be bought on the ASX via a broker or online share trading account. The bonds are generally fixed with interest payments made to you every 3-6 months over the duration of the security.
So if you’re ready to invest, how can you gain access to the bond market? There are several ways to get started including buying the bonds directly from the issuer, or gaining exposure through investment products listed on the ASX.
Not sure how bonds work or need a refresher? Check out this article.
1) Investing in individual bonds
The only way to invest in individual bonds is to buy them directly from the issuer (for example, the company) and it is similar to purchasing an IPO. However, for the average investor, this can be quite difficult, as most issuers only offer bonds to certain parties – typically institutional investors. Although, if you are interested in a particular bond, you may be able to find a broker who may be able to arrange this for you. They should provide you with the paperwork and a prospectus with more information on the opportunity. It is important that you read the prospectus carefully before investing.
As investing in individual bonds is out of reach for most retail investors, to gain exposure to this market an alternative are bond funds. These investment funds are made up of various bonds and other debt instruments, and there are a number of ways to access them.
Compare Online Share Trading Accounts with Canstar
If you’re comparing online share trading companies, the comparison table below displays some of the companies available on Canstar’s database with links to providers’ websites. The information displayed is based on an average of six trades per month. Please note the table is sorted by Star Rating (highest to lowest), followed by provider name (alphabetical). Use Canstar’s Online Share Trading comparison selector to view a wider range of online share trading companies. Canstar may earn a fee for referrals.
2) Investing in Bond ETFs
Bond ETFs are available on the ASX, therefore anyone with an online share trading account can access them. When you invest in a bond ETF, generally you will be investing in a fund that tracks the bond market and replicates its returns. Some ETFs track specific types of bonds, for example, just corporate bonds or government bonds.
Related article: What is an Exchange Traded Fund (ETF)?
Investing through a bond ETF doesn’t mean that you miss out on dividends. Typically, bond ETFs pay out interest monthly, while any capital gains are paid out through an annual dividend.
Compare Exchange Traded Funds (ETFs) with Canstar
The table below displays some of the International Broad Based ETFs available on Canstar’s database with the highest three-year returns (sorted highest to lowest by three-year returns and then alphabetically by provider name). Use Canstar’s ETFs comparison selector to view a wider range of products. Canstar may earn a fee for referrals.
3) Investing in bonds through managed funds
Most managed funds will also be able to provide exposure to the bond market. While investing in bonds through managed funds is similar to bond ETFs, the difference is managed funds are overseen but a professional fund manager.
Fund managers will select the bonds and other securities to invest in and try to match them with their clients’ ideal asset allocation. They will also actively try to beat the market and aim to deliver their clients’ strong returns. However, bear in mind, this service comes at a cost and will often be pricier than standard ETF fees. So, make sure you shop around before deciding on the right managed fund for you.
4) Investing in bonds through your super
Another way to access bonds is through your superannuation. In fact, most super funds allow you to invest solely in fixed interest assets like bonds and cash. However, if you are looking to diversify your investment portfolio, generally a mix of defensive assets and growth assets is recommended.
Compare Superannuation with Canstar
The table below displays some of the superannuation funds currently available on Canstar’s database for Australians aged 30 – 39 with a super balance of up to $55,000. The results shown are sorted by Star Rating (highest to lowest) and then alphabetically by provider name. Performance figures shown reflect net investment performance, i.e. net of investment tax, investment management fees and the applicable administration fees based on an account balance of $50,000. To learn more about performance information, click here. Use Canstar’s superannuation comparison selector to view a wider range of super funds. Canstar may earn a fee for referrals.
Fee, performance and asset allocation information shown in the table above have been determined according to the investment profile in the Canstar Superannuation Star Ratings methodology that matches the age group specified above.
The risks involved
While bonds are generally considered a safer investment option compared to shares, it does not mean that they are without risk. The main risk investors face with bonds, is the chance that the bond issuers will default on the loan and not be able to pay the interest owed to investors. So depending on the bond you are invested in, some are less risky than others. Corporate bonds, for example, are seen as riskier than government bonds, as the chance of a government default is minimal.
Interest rate risk should also be considered when investing in bonds. Typically, as interest rates rise the value of bonds falls. This is because investors can take on less risk by moving to cash investments with a competitive interest rate. Therefore, making bonds a less attractive investment option.