Are you interested in investing in bonds, but not too sure how they work? Or maybe you’ve got a basic understanding of bonds, but want some more information on the best bonds to buy in 2019?
Whatever your reason, you should know that bonds come in a full range of shapes and sizes. Whether its corporate bonds, government bonds, fixed-rate bonds, savings bonds, or property bonds, there’s something to suit all risk levels.
As such, before you begin your bonds investment journey, be sure to read our comprehensive guide first. We’ll cover everything you need to know, from how bonds actually work, where you can buy them from, how much money you can make, and what risks you need to consider.
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What is a Bond?
What better place is there to start than by explaining what a bond actually is? So, when you purchase bonds, you are effectively lending money to the company or government that issued them. Institutions issue bonds as a means to raise money, and thus, pay you interest in return for your investment.
This is usually paid once per year, however, some bonds pay interest every three months. Once the bonds expire, you will then receive your original investment in full.
The interest yield that you receive on your bonds can vary enormously. This will depend on a range of factors, such as the length of the bond agreement, and the level of risk associated with the issuer.
Let’s explore a quick example to ensure you have a basic understand of how a bond agreement works.
Although the above example is super basic, hopefully it gives you a better idea of how a bond agreement works.
What Different Types of Investment Bonds are There?
There is a vast range of bond types that people invest in, each with different characteristics. Below is a list of the main bonds that people invest in.
- Corporate Bonds: Bonds issued by large companies
- Government Bonds: Bonds issued by governments
- Property Bonds: Bonds backed by property, or to fund property developers
- Savings Bonds: Bonds issued by banks or building societies
- Bond ETFs: Trade bond prices on the open marketplace without owning the bonds
- Fixed-Rates Bonds: Bonds that pay a fixed amount of interest until they mature
- Bond Funds: This is when you allow an experienced fund manager to buy, sell, and trade bonds on your behalf
Why do People Invest in Bonds?
Much like in the case of any other asset class available in the investment sphere, people invest in bonds to make money. But what sets bonds apart from other investments? Check out the following factors that motivates investors to buy, sell, and trade bonds.
In the vast majority of cases, bonds will always pay a fixed rate of interest, at a fixed point in time, which is always determined before the investment is made. This means that if you hold on to your bonds until they expire, then you know exactly what you are going to make. This is perfect if you want to make a passive income. Although some bonds are a lot riskier than others, some are virtually risk-free. For example, if you invest in U.S Treasuries, which are bonds issued by the U.S. government, the only way you could lost your money is if the government collapsed. In this sense, investors are accustomed to practically no risk. If you’re the type of investor that likes to diversify your portfolio to minimize risk levels, then bonds can help you achieve this aim. In fact, there is often an inverse correlation between bonds and the stock market. This means that as the value of the stock market goes up, bond prices go down. Therefore, adding a range of bonds into your investment portfolio can allow you to diversify with ease. Certain bonds, such as those issued by the U.S. government, are not attributable to tax. As such, holding a selection of government bonds is a great way to minimize your tax liabilities, and thus, earn interest without it affecting your annual threshold. Although the vast majority of bonds are fixed-rate, this doesn’t mean that the bonds can’t be traded on the secondary markets. In fact, the trading of bonds between institutions is now a multi-trillion dollar sector. The price of the bond is determined by its interest rate. As the interest rate will fluctuate depending on demand and supply, some traders like to invest in bonds so that they can speculate on the future direction of interest rates. Learn More: The Federal Reserve And Interest Rates
In the vast majority of cases, bonds will always pay a fixed rate of interest, at a fixed point in time, which is always determined before the investment is made. This means that if you hold on to your bonds until they expire, then you know exactly what you are going to make. This is perfect if you want to make a passive income.
Although some bonds are a lot riskier than others, some are virtually risk-free. For example, if you invest in U.S Treasuries, which are bonds issued by the U.S. government, the only way you could lost your money is if the government collapsed. In this sense, investors are accustomed to practically no risk.
If you’re the type of investor that likes to diversify your portfolio to minimize risk levels, then bonds can help you achieve this aim. In fact, there is often an inverse correlation between bonds and the stock market. This means that as the value of the stock market goes up, bond prices go down. Therefore, adding a range of bonds into your investment portfolio can allow you to diversify with ease.
Certain bonds, such as those issued by the U.S. government, are not attributable to tax. As such, holding a selection of government bonds is a great way to minimize your tax liabilities, and thus, earn interest without it affecting your annual threshold.
Although the vast majority of bonds are fixed-rate, this doesn’t mean that the bonds can’t be traded on the secondary markets. In fact, the trading of bonds between institutions is now a multi-trillion dollar sector. The price of the bond is determined by its interest rate. As the interest rate will fluctuate depending on demand and supply, some traders like to invest in bonds so that they can speculate on the future direction of interest rates.
Learn More: The Federal Reserve And Interest Rates
Pros and Cons of Investing in Bonds
Before you buy bonds, be sure that you make some considerations regarding the pros and cons of making an investment.
How To Invest in Bonds in the U.S.A.
When corporations issue new bonds, they specify a minimum amount that you can invest to access the offering. As the minimum is usually well into the millions of dollars, it’s likely that you won’t be able to buy bonds directly from the company that issued them. This is why you will need to use an online broker. The broker in question will purchase a significant number of bonds on behalf of their clients, and then sell them via their online platform
On the other hand, bonds sold by the U.S. government can now be purchased directly from the U.S. Treasury Office website. This means that there is no need to go through a third party, and thus, will not cost you any fees or commissions.
How We Rank U.S. Online Bond Brokers
As the buying and selling of bonds is now hugely popular with online investors, there is now a considerable number of bond brokers. While competition is always a good thing, this can also make it difficult to know which one to choose. Check out our list below which outlines the main factors we look out for before recommending a bond broker.
Top 5 U.S. Bond Brokers for 2019
Top 5 U.S. Bonds 2019
Although there are literally thousands of bonds to choose from, we’ve decided to list five of the best for 2019 and beyond. Each bond will have its own risk attached to it, which should be reflected in the annual yield on offer. If you do like the sounds of one of the five bonds listed below, make sure that you perform your own research prior to making an investment.
How Does a Bond Investment Work?
If you are attempting to learn how bonds actually work, then its important that you have an understanding of "Risk vs Reward". In a nutshell, the higher the risk of the company or government that issues the bonds, the higher your returns should be.
In order to figure out whether a bond investment is good value or not, you should also have a firm understanding of two key terms - maturity and yield.
When we talk about the maturity of a bond, this refers the date that the bonds will expire. So, when a company or government issues new bonds, they will always have a maturity date. Up until this point in time, the bond holder (investor) will be paid fixed interest payments. When the bonds do mature, the bond holder is paid their original investment back in full.
The reason that the maturity date is important is because it has a direct correlation to risk. In other words, the further away the maturity date, the more chance there is that the issuer will default.
Think of it like this: If you lent your friend $1,000 with a payback period of 1 month, and another friend $1,000 with a payback period of 10 years, which loan do you think is more risky?
In its most basic form, the yield is a term used to describe the amount of interest you will be paid for holding a bond. The interest is always expressed as an annual figure, even if the interest is paid on a monthly or quarterly basis.
The interest yield on bonds is expressed as a percentage, meaning that you can easily calculate how much your investment will be worth when the bonds mature.
As noted earlier, the higher the risk of the bond, the higher the yield will be. This is also the case for the length of the bond, insofar that the longer the bond has before it matures, the higher the yield.
Who Issues Bonds?
In terms of who issues bonds, this will either be by a company, or a government. Known as corporate bonds, companies issue bonds as a way to raise funds for a particular project or investment. They often choose this option instead of issuing more shares as it allows the company to retain its equity. Governments, on the other hand, will issue bonds as a way to pay for front-line public services, such as law enforcement or the military.
Trying to understand the difference between the two is often confusing, so we've explained each type in more detail below.
Virtually every government around the world issues bonds as a way to fund public services. This is usually the case because annual tax revenues were not quite large enough to meet the national budget. In the U.S., government bonds are referred to as Treasury Bonds, or simply T-Bills.
They work in exactly the same way as corporate bonds, insofar that the government will pay you a fixed amount of interest until the bonds expire. Government bonds are also traded on the secondary market, whereby the value of the bonds can go up or down.
In terms of the risk levels, the only way that your funds are at risk is if the government defaults on payment. Now, in the case of the U.S., its all-but impossible for the U.S. government to default on its bonds payments. If the government experiences a short-fall in cash reserves, they can simply print more money, as the U.S. dollar is the reserve currency of the world.
On the other hand, bonds issued by emerging countries are a lot more risky. As you'll see from the 10 year bond yields listed below, there is a large disparity in annual interest payments depending on the government issuing the bonds.
- UK: 1.14%
- USA: 2.47%
- CANADA: 1.73%
- AUSTRALIA: 1.74%
- GREECE: 3.52%
- BRAZIL: 8.79%
- INDIA: 7.41%
Outside of government bonds, you can also invest in corporate bonds. As noted above, these are issued by companies of all shapes and sizes. They work in exactly the same way as government bonds, however, they are often regarded as higher risk. The main reason for this is that if the company runs into financial trouble, they don't have the option of printing more cash.
Just like government bonds, there can be a huge disparity in the annual yields on offer, which is directly linked to the underlying risks. Check out some of the examples we've listed below.
- Anglo American Capital: 4.125% (expires September 2022)
- HSBC Bank: 5.375% (expires November 2030)
- Marks and Spencer: 4.75% (expires June 2025)
- Severn Trent: 6.125% (expires February 2024)
In conclusion, investing in bonds is an excellent way to earn regular interest payments without needing to worry about actively trading. If you're prepared to hold on to the bonds until they mature, then you will receive annual or quarterly interest payments at a pre-defined, fixed rate. This is really useful if you are the type of investor that likes to know exactly how much they are going to make, rather than leaving it to market forces.
As we have discussed throughout our guide, although bonds are often referred as one of the lowest-risk assets in the investment space, some bonds are a lot riskier than others. At the lower end of the spectrum, government bonds issued by the likes of the U.S. are virtually risk-free. However, if buying bonds from a corporation that isn't performing too well, then the risks are a lot higher.
This is why it's crucial to assess the underlying "Risk vs Reward" model. Ultimately, if a particular bond appears to have more risk attached to it, then you should be rewarded with a higher interest yield.
How do bonds works?
When corporations or governments need to raise cash, they issue bonds. If you buy a bond, you are a bond holder. By being a bond holder, you are entitled to be paid regular interest until the bonds mature. When they do, you'll receive your original investment back in full.
Is my money tied up when I buy bonds?
In order to receive fixed-rate interest payments, and then your initial investment back in full, you need to hold onto the bonds until they mature. However, some bonds - especially those issued by the U.S. government, can be freely traded on the open market. As bond prices can fluctuate, you might get less than what you paid if you attempt to sell them early. For bonds to go down in value, this would indicate that the marketplace believes there is more risk attached to them compared to when the bonds were originally issued. On the other hand, if the bond issuer is in a clean-bill of financial health, then its likely the value of the bond will sell at a premium.
Are corporate bonds and government bonds the same?
Government bonds and corporate bonds operate in exactly the same way. As the name suggests, the only difference is that one is issued by a government, and the other is issued by a corporation (company).
How do Bond ETFs work?
ETF stands for exchange traded fund. An ETF is a financial asset that tracks a particular market. This could be anything from Gold, real estate, and of course - bonds. As such, a bond ETF will track the market prices of a particular bond, or group or bonds. It is important to note that bond ETFs were designed in such a manner that investors can speculate on whether the value of the bond will increase or decrease. As such, you will not be able to earn fixed-income dividends, not least because bond ETFs never expire.
How risky are bonds?
In a nutshell, there isn't an investment in existence that can ever be classed as 100% risk-free, as anything is possible. While it is true that financial analysts often describe bonds as low-risk, this isn't true for all bonds. For example, government bonds issued by leading economies such as the U.S., Japan, Germany or the UK are virtually risk-free, as its all-but certain that the government will not default.
However, bonds issued by nations such as Venezuela, Belize, Moldova, and other emerging nations, are typically very high-risk. As you'll see from the image below, even the likes of Greece has previously defaulted on its bond payments. The E.U. nation, which uses the Euro as its primary currency, defaulted to the tune of 1.6 billion Euros! When it comes to bonds issued by corporations, these also come with their own risks. One only needs to look at the collapse of the Lehman Brothers in 2008 to recognise that even the largest companies in the world can default on their bond obligations. Ultimately, your best bet is to diversify across multiple bonds.
Can all governments print money to meet their bond debts?
This depends. For example, the U.S. has full control over the dollar, and thus, it can print more money as and when it sees fit. However, the major economies of Germany, Italy and France all use the Euro, and thus, they are bound by the authority of the European Central Bank. In the case of emerging countries such as Venezuela, although the government can print more money, its domestic currency is virtually worthless in the open marketplace, meaning that bond holders would still lose out.
How much do bonds pay?
The yields on bonds vary wildly. At the lower end, you'll make in the region of 1-2% with U.S. Treasury Bonds, as they are ultra low-risk. At the other end of the spectrum, government bonds in emerging countries can pay double-digits.
Can I cash-out my bonds early?
If a secondary marketplace exists, and there is enough demand, then yes, some bonds can be sold before they mature. The bond market is dominated by leading government bonds such as those issued by the U.S. and Japan. Some corporate bonds can be traded before they expire, however, volumes are minute in comparison to government bonds.
Is it easy to buy foreign government bonds?
Buying U.S. Treasuries is easy. However, when it comes to buying bonds issued by foreign governments, this is no easy feat unless you are an institutional investor. What you can do is invest in a bond ETF, as these are much more accessible for the average investor.