When we buy a bond, we’re lending money to a government, council or company. In return they promise to pay us a certain interest rate. Bonds are different from term deposits in that we can sell them. We don’t have to hold them till ‘maturity’ – the date we get our money back. However, the price we will get if we sell our bonds early can go up or down.
Bonds usually pay a higher interest rate (‘coupon’) than bank deposits. So they can be a good option if a steady income from savings is a priority.
If we hold our bonds till ‘maturity’ and the company or government doesn’t fail, we will get back what we put in, plus the interest rate promised.
However if we sell our bonds early, the return we receive may not be exactly the same as the ‘coupon’ rate. How much we get back will depend on how desirable the bond’s interest rate is at the time we sell.
Bonds are considered safer than shares, but still have some risks.
This includes interest rate risk, where market rates rise and we find that we’re earning less from a bond than we could with other investments.
There is also inflation risk, where a high rate of inflation lowers the value of the interest we earn.
Other risks include liquidity risk, meaning we can’t find a buyer when we want to sell.
Some bonds are safer than others. A government or council bond may be safer than one issued by a company. The downside is that safer bonds tend to have lower interest rates than riskier ones.
Some bonds are ‘rated’, which means they have a credit rating as a guide to how risky they are.
If a bond is ‘senior’ it means that if the company or government fails, we will have a higher priority in the queue of people trying to get their money back. If the bond is ‘subordinated’, we will be further down that queue.
Subordinated bonds are more risky than senior bonds and will usually have a lower credit rating.
As with any investment, it pays to do homework and to get professional advice before investing in bonds – particularly if there is a chance you will sell before maturity. The Financial Markets Authority has more information on how to protect yourself when you invest in bonds.
Individual bonds are traded on bond markets such as the NZX Debt Market.
Bonds can be bought through a sharebroker (some banks offer this service) or an online service. Prices of bonds that can be traded are published on the NZX Debt Market website and in newspapers.
Managed fund providers also offer bond funds. These fund managers pool buyers’ money and spread it across a number of different bonds. A bond fund lets you ‘diversify’ your money rather than putting it all into one single bond holding, so all your eggs are not in the same basket.
Bonds are often part of the investment mix in KiwiSaver.