Mention the word ‘bond’ to most people, and thoughts of 007 come to mind. But bonds are a type of fixed interest investment that can add diversity to your portfolio.
Bonds work like a loan from you to the bond issuer, usually a large company or government body. There are several types of bonds however most pay a fixed rate of interest, with payments made quarterly, 6-monthly or annually, for a set term – often long periods of around 20 years.
At this point bonds may sound a lot like term deposits. And if you held a bond from the date of issue to the date of maturity, it would undoubtedly work in a similar way. A key difference is that many bonds can be traded (bought and sold) on the Australian Securities Exchange (ASX) and you may decide to invest in a bond for only a part of the bond’s ‘lifespan’.
Market values can rise or fall
The ability to trade bonds means their market value can change. For example, if a bond is paying interest of 7%, its market value will rise if market interest rates fall to say, 3%. That’s because the bond is paying a regular payment (called the coupon) at 7% p.a. which looks something like a term deposit.
The level of risk associated with bonds is closely related to the bond issuer. There could be a risk that the issuer won’t be able to pay the interest when it is due (credit risk), or that the value of the bond will fall when interest rates go up (market risk). A Commonwealth government bond for instance is extremely low in credit risk. It can be challenging for investors to assess the risk associated with bonds, and this is an area where financial advisers can offer expert information.
Bonds can bring an extra layer of diversity to your portfolio, with the added appeal of regular interest payments. Call me for more information or to work out if bonds are suitable for your investment strategy.