Bonds 101: How to Invest in the Bond Market

Mixing up your usual routine can add a little bit of flavour into your life, and sometimes that flavour was just what you’ve always needed.  Adding bonds to your portfolio of investments, likewise, is a great idea if you are looking to add diversification benefits to your portfolio – enhancing the rate of return on your money and reducing the risks.

What Are Bonds?

Bonds are a financial contract with a prespecified rate of return. They are like an IOU – either issued by a business or a government.  As an investor your money goes to the bank or business and they promise you a rate of interest and to return your full amount of original investment at a pre specified date in the future.

Bonds are also commonly referred to as fixed income investment or fixed interest investments – this is because they pay a fixed rate of return. The two main types of bond – government bonds, which are known as gilts, and corporate bonds, which are the ones issued by companies.

Why Do People Invest In Bonds?

The main reason that investors add bonds to their portfolios is to add variety. By diversifying your investments, you reduce the risk and improve the chances of a better return on your money invested. Keeping a portfolio of a mix that includes bonds, stocks and cash as a base of investments is a good idea; if there is a downturn in a segment of the market you do not lose all of your wealth in one go.

Bonds normally pay interest semiannually, which means they give investors a predictable income return.  Bonds are also a good choice if you are looking for your original investment to have a high chance of being fully protected. Bonds are a good investment choice for long term investing – such as for your retirement or for a new home for later in life.

How Can A Bond Benefit You?

Whatever your financial goals, investing in bonds is a good choice that will help you achieve your objectives. Investing in bonds has a lower risk than investing in stocks and because of this lower risk, they will give you a lower level of return.

Common Risks of Bond Investments?

Government bonds, known as gilts, are normally the safest type of bonds. This is because governments are less likely to fail to repay your capital or fail to pay your interest – if the party who issues the bond does this they are said to “default on their debt”.

This is the biggest risk of buying bonds and applies more so for corporate bonds. These are riskier than government bonds but still lower risk than equity markets.  Corporate bonds are issued by companies and corporations and this means that if that business goes bankrupt you might not get your some or all of your money back. Although this is unlikely to happen if it did you would get your invested money back before shareholders.

How And When Do You Need A Bond?

The key reason to purchase bonds is to diversify your portfolio. You can buy almost all bonds at your brokerage or local bank. Brokers may charge a small commission or they may mark up the bond price instead – clarify this with your broker before confirming that you want to buy.

Different Types Of Bonds

Government bonds are issued by national governments. Corporate bonds are those issued by businesses. High-risk/high-yield fixed income are known as junk bonds – these types of bonds may promise you a high return but in exchange you are facing a high risk of losing your money. A convertible bond gives you a financial performance that works as a bond in certain market conditions and like a bond in other market conditions – it is more versatile in giving you a return so can be more expensive than standard fixed income.

Bond Ratings

So you can better understand and see which bond is riskier and which is safer the financial marketplace has a system of credit ratings. Bonds rated AAA to BB are known as investment-grade bonds – these are less risky and are normally issued by the larger, blue-chip companies and governments. With these you have a high likelihood of receiving your initial investment and interest payments in full and on time. On the other hand, fixed income rated BB to D are known as high-yield bonds (also as junk bonds). These fixed income pay a higher rate of interest but are also much riskier.

Here’s How To Get Started In Bonds!

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