Diversify your investments with little risk by choosing bonds over your typical savings account.
With a high interest savings account you are able to keep your excess funds in an account that earns interest while maintaining access to the money in most cases. When you invest that money in a bond instead, you lose that immediate access to the cash but you could see a higher return on your investment without the terms that are often applied to a savings account.
What is a bond?
A bond is a low risk investment product where you are lending money to either the Australian government or a company at a fixed interest rate for a pre-determined period of time. You will then receive interest payments on your investment on a regular basis, with the principal amount paid back to you at the end of the term. Before making a choice in investing in bonds however, you should carefully compare your options as some will pose more risk to the lender than others.
How does a bond work?
Edith has been transferring her spare cash into her Bankwest Hero Saver Account for the last two years, but is now considering buying her first home in the near future. Wanting to ensure that she has enough to meet the down payment requirement, she decides to invest the money into a higher interest paying product, which will also limit her access to the funds. Edith chooses a Commonwealth Government Security (CGS) bond, which will pay her interest twice a year on the investment. This is a low risk option for her savings where she will receive her investment back in full at the end of the term she has chosen.
By choosing a government issued bond for her savings, Edith is able to diversify her investment portfolio, keeping a percentage of her money inside of the Hero Saver Account where she can still add to the balance, earn interest, and withdraw those funds as needed. The interest earned on her government savings bond will be added to this account where it will then earn more interest that can be used towards her home purchase in the future.
What are the different types of bonds?
In Australia you have a few different options when diversifying your portfolio by 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 and sold on 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 being made to you every six 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 affected by the cash flow of the business. With corporate bonds, you are a creditor and your return limited only 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.
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Are bonds safe?
Australian Government bonds are considered to be very safe, but there are bond options that can carry a high level of risk if you are not careful. Bonds are typically less volatile than other types of investments, such as shares, but you can see losses in some years even with government issued bonds. Bonds do come with a credit rating, but you will need to consult with a licensed financial adviser in order to access that type of information.
How are bonds valued?
A bond’s capital value can increase or even decrease before the maturity date based on the 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?
If you are interested in diversifying your savings opportunities with bonds, you can use an online broker to help you make your initial investments. Certain Australian banks, like the Bank of Queensland, also have specialised accounts that allow you to invest in low risk bonds for a specific term. There is a minimum investment amount required for this type of account, but your rate of interest and return is guaranteed for the life of your investment.
How are bonds and savings accounts similar and different?
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Asses your financial situation to determine whether investing in a Government bond is right for you.
Say there is a severe global financial crisis (much worse than 2008 GFC) and the Australian Government cannot or decides not to meet its obligations under Australian Government Guarantee Scheme would a deposit in Australian Government bond be safer?
Many thanks, Dan
Hi Dan!
Interesting question you have there! :)
Bonds, even government bonds carry a little risk than the average deposit account, because of they are influenced by several economic factors and political instability. But compared to savings account, interest payments or also known as “coupon payments” are usually higher.
Most savings account have fixed rates and are covered under Australian Guarantee. But their rates are lower than bonds.
This is where diversification and thorough research are both very important. Different precautions you might take are to never “put all your eggs in one basket”, invest in different bonds if you’re uncomfortable with stocks, and spreading out your deposits.
IF you’re uncertain about the strategy you’d take, you may speak to a financial adviser.
Hope this helps.
Cheers,
Jonathan