How do you invest in the bond market? A beginner’s guide
Protect your portfolio against volatility by investing in government or corporate bonds
Government and corporate bonds are considered one of the safest investments in the market. When you invest in the bond market, you're essentially lending money to a business or to the government at a fixed interest rate.
While you can’t usually expect the same high returns by investing in bonds as you get from shares, you can expect a lot more security. For this reason, the bond market does especially well as the share market becomes more volatile and interest rates fall.
If you're ready to start investing in bonds, there are several avenues that you can take, including wholesale investing via a company or broker, and through investment products listed on the ASX, such as exchange traded bonds and bond-themed exchange traded funds (ETFs).
What is a bond?
Simply put, a bond is a loan that you make to either the Australian government or a company at a fixed interest rate for a pre-determined period of time. In return, you receive interest payments on your investment on a regular basis, with the principal amount paid back to you at the end of the term.
Where shares normally return value as the stock markets rise, bonds act as a counterweight to a portfolio because they tend to do better when the economy is under-performing. Before making a choice, you should carefully compare your options as some will pose more risk than others.
In Australia you have a few different options when investing in bonds. Each choice has its own risk and return potential, making it important that you compare your options carefully before deciding on any one product:
- Australian government bonds. Commonwealth Government Securities (CGS) are issued by the Australian government. These can be bought directly over the counter (OTC) or via the ASX through a broker or an online trading account. The face value of these types of bonds is fixed along with the interest rate, with payments made to you every 3-6 months over the life of the security.
- Corporate bonds. This type of bond is usually a part of a public offer, where a company will issue a prospectus and investors are able to make a direct investment. This is different from buying shares, where you are a part owner and your investment is affected by the cashflow of the business. With corporate bonds, you are a creditor and your return is limited to the agreed upon interest payments and the return of your principal investment.
When looking at your bond options, you should also check how the interest rate works. In some cases you could find a floating rate bond, where the interest varies in line with the benchmark interest rate. You have the opportunity to earn higher returns with this type of investment, but there is also a risk of lower returns if the interest rate drops.
How are bonds valued?
A bond’s capital value can increase or even decrease before the maturity date based on current interest rates. The amount of interest accrued since the last coupon payment will also have an effect on the value of a bond. If interest rates drop, you will see an increase in the value of your bonds, whereas when they rise the value of your bonds will drop as a result. These fluctuations are only relevant if you have invested in floating rate bonds as opposed to fixed rate bonds.
How do I start investing in bonds?
You can invest in bonds either over the counter (OTC) or via the Australian Securities Exchange (ASX). In both cases you'll be required to have a broker or fund manager. OTC bond investing usually requires a high minimal investment (upwards of $500,000); however, your rate of interest and return is guaranteed for the life of your investment. Investing in bond products via the ASX means you can invest for as little as a few hundred dollars through a broker or online trading platform.
An easy and relatively cheap way to access the bond market is through exchange traded funds (ETFs) or exchange traded bonds (XTBs + ETBs). These products can be bought and sold on a stock exchange through an online trading platform or a full service broker. If you're considering investing in bonds through an online broker, be aware that there may be additional risks involved – especially if you don't understand the product.
- Bond ETFs. An exchange traded fund is a bundle of securities that has been listed on a stock exchange. Bond ETFs typically track a corporate or government bond index to imitate its returns; however, it's important to note that not all fixed interest ETFs are the same or are necessarily safe. Hybrid bond ETFs may contain additional riskier derivatives products – always do your research.
- Exchange traded corporate bonds. While most bond ETFs track an index or basket of bonds, an exchange-traded bond unit (XTB) relates to a single ASX-listed corporate bond. Each XTB mirrors a specific underlying bond. This means they provide predictable income amounts, dates (coupons) and fixed maturity dates before you invest. Still relatively new, XTBs launched in Australia in 2015. Like ETFs, you buy and sell XTB units on the ASX with minimum amounts starting from $500. There are currently around 50 XTBs available on the ASX.
- Exchange traded Australian government bonds. Exchange-traded treasury bonds (ETBs) and exchange-traded treasury indexed bonds (ETIBs) work the same way as XTBs; however, they track government bonds. Both provide fixed interest returns for the life of the security, but the value of ETIBs is adjusted with the consumer price index (CPI), meaning the interest received can fluctuate.
Invest in bonds via CFDs
An alternative to buying bonds is to speculate on their price movements through CFD investing in the futures market. CFD investors seek to profit from bond price movements – whether up or down. That means that even if bond values are falling, CFD investors can still make a profit. However, because CFDs can be highly risky and are complex derivative products, CFDs are better suited to advanced traders. You can read more about CFDs in our comprehensive guide.
How are bonds and savings accounts similar and different?
Are you thinking of moving your funds from a savings account into government bonds? If so, there are several considerations you need to be aware of, such as the bond's maturity date and minimal investment requirement. Below are some pros and cons of investing in bonds versus keeping funds in a savings account.
Remember, before you get started, it pays to asses your financial situation to determine whether investing in government bonds is right for you.Back to top
Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, options or any specific provider, service or offering. It should not be relied upon as advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involve substantial risk of loss and therefore are not appropriate for all investors. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.
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