Before you can dive headfirst into the world of investing, it’s important to gain an understanding of how things work. Bonds are one method of growing your money through investing and they come with a lot of options and factors that you should wrap your head around before wrapping your money in them.
Here’s everything you need to know about bonds.
What are bonds?
Governments and companies regularly borrow money from investors by issuing bonds. At a simple level, bonds are a form of IOU which define the terms of the borrowing. When you invest in bonds, you are essentially lending your money to the issuer i.e. the borrower which are typically governments and large companies.
How do they work?
In exchange for lending your money to them, these companies have to pay interest. These interest payments are made at an agreed rate and frequency until the loan has been completely paid back – also know as the maturity date.
Bonds represent debt obligations – and therefore are a form of borrowing. Source: Investopedia
What are the advantages of buying bonds?
Bonds are low risk and conservative forms of investment. Unlike shares, bonds are ‘fixed-income securities’ because as the lender, you know the rate at which you have lent your money at the time you purchase the bond. You are guaranteed to get your money back if a bond is held until maturity and the borrower does not default.
Read more: A beginner’s guide to asset classes
What are the different types of bonds?
The three most common types of bonds are:
These can be issued by national governments and lower levels of government and are typically referred to as ‘sovereign’ debt.
These are typically issued by large companies.
These are form of fixed income security which are typically created by packaging up cash flows of similar assets, which serve as a collateral for the borrowing. They are typically issued by banks or other financial parties and tend to be reserved for sophisticated or institutional investors rather than individuals.
How do you buy bonds?
There are three main ways bonds can be traded:
When bonds are purchased directly from the borrower at the time the bond is issued, this typically called a primary market purchase. Primary market is typically available to sophisticated or institutional investors only.
When bonds are traded between investors, this is typically called a secondary market transaction. You have the option of opening an account with a specialised bond broker to buy bonds directly, but this often requires high minimums and the cost of trading can be prohibitive for individuals.
Mutual funds & Exchange-traded funds
Mutual funds which invest in bonds are often called bond funds. These funds invest in a large number of bonds based on a pre-determined criteria. In addition to mutual funds, there are also exchange-traded funds which invest in bonds with a pre-determined criteria. Similar to stocks, exchange-traded-funds trade on the exchange and experience price changes throughout the day as they are bought and sold.
Read more: What are exchange-traded funds?
Here at Clover, we invest your money in exchange-traded funds that include different asset classes (including bonds) in a way that’s personalised to you. Learn more about our investment strategy and why we use Modern Portfolio Theory to optimise returns for our customers.
Also published on Medium.