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. The regular interest payments can provide a steady income and bonds can also help create a diversified portfolio, making bonds an attractive investment for some. So, how can you gain access to the bond market?
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 it 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 investors, typically institutional investors. Although, if you are interested in a particular bond, your broker may be able to arrange this for you. They should provide you with the paperwork and a prospectus. 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.
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.
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 it 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.
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 defaulting is minimal.
Interest rate risk should also be considered when investing in bonds. Typically, as interest rates rise the value of bonds fall. 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.
Originally published by Marissa Prince.
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