Bonds are usually described as safe and stable because they are a fixed-rate security and you get your money back if you keep the bond until the maturity date.
Investors are happy to have bonds in their portfolio when the stock market is uncertain or when interest rates are declining. Bonds have a lower risk than equities, but do not provide the same high return over time.
So, how do you invest in bonds?
The easiest way is to buy and sell bonds through a so-called online broker, such as Robinhood or Webull. As bonds are often sold in items of 100 000, it can be an advantage for you as an individual to save in one or more bond funds. For a really capital-rich investor, government bonds and / or corporate bonds are preferable, which can also be bought via a broker.
What is a bond?
A bond is, in short, a loan. The state or a company can issue and sell bonds instead of borrowing money from a bank. The state / company then pays interest to the owner of the bond.
When a government borrows money it is called government bonds, and when a company does it it is called corporate bonds.
Bonds are traded as a percentage of their original loan value, which is called the nominal amount. Bonds have a certain maturity and when they mature, the lender normally gets back 100% of its investment.
In other words, the loan will be repaid.
What is the difference between stocks and bonds?
A bond is a liability in the companies’ balance sheet, while shares are equity on the asset side.
If you buy shares, you become a partner in the company and if you buy bonds, you act as a bank and lend your money for a period of time.
If you own shares, you can take part in increasing profits, dividends and price increases (hopefully) over time, in addition you have the right to vote.
Bonds do not increase in value and you are not allowed to take part of the company’s profits, but what you get is a predetermined interest rate every year.
An advantage of bonds is that because it is a debt for a company, you get paid before the shareholders in the event of bankruptcy.
Therefore, it is often said that bonds have a lower risk than equities.
How do bonds work?
Bonds are traded as a percentage of their original loan value, the so-called nominal amount. If a bond is traded in items of $1000 and the price is 103%, this means that, without including fees, it will cost $1300 to buy an item.
There are two main types of bonds, zero coupon bonds and coupon bonds.
So-called zero coupons are issued at a discount and then have no current interest during the term, while a coupon bond annually has a certain interest that is paid out, much in the same way as a savings account.
Top 6 Different Types of Bonds:
1. What are premium bonds?
A premium bond is a type of bond issued by the Debt Office. The interest is collected in a pot which is then raffled off among the bondholders.
You usually have a guaranteed profit if you have 10 bonds in sequence, and that means that you get a guaranteed interest rate.
In addition, they participate in the raffle of the rest of the interest.
All winnings are tax free. Since December 2016, the Debt Office has stopped issuing new premium bonds, but it is possible to buy the premium bonds that have already been issued.
They will run as usual and the winnings will be deducted according to plan.
2. What are government bonds?
The state can issue and sell bonds instead of borrowing money from a bank.
Then the government pays interest to the person who owns the bond and this is what is called government bonds.
3. Corporate bonds
A corporate bond can be described as both a corporate loan and a security that can be bought.
A company that is in need of loan financing mainly has two options to choose from: By taking out a bank loan or by buying a corporate bond.
This means that a corporate bond is a type of promissory note that is issued by a company, and then sold to an investor. The reason why the company chooses to issue bonds is to raise money for the business.
In comparison with government bonds, corporate bonds generally give higher returns, but they are also associated with higher risk.
4. Green bonds
A green bond means capital that is earmarked for various environmental projects.
Depending on how the money is to be used and how the coupon is designed, there are different types of green bonds.
Anyone who has a pension insurance with, for example, Alecta, SPP or SEB has in all probability invested part of the capital in one or more green bonds.
5. What does a coupon bond mean?
A so-called coupon bond is a bond that has a current half-year or full-year interest rate.
The term coupon bond originates from the past when securities were often provided with a coupon that was torn, or “cut”, in connection with the interest being paid.
Coupon bonds are characterized by having a specific maturity, a so-called nominal value and a fixed interest rate that applies throughout the term (also called a coupon rate).
There are also bonds called zero coupons, which are the exact opposite of coupon bonds.
In this case, the interest rate is built into the price because these bonds are sold at a discount (any profit is paid out in connection with the maturity of the zero-coupon bond).
6. What does covered bond mean?
A covered bond can be described as a bond with a collateral consisting of mortgage loans.
The loans are in turn associated with some form of mortgage, for example in a property, and with the credit institution as guarantor of the debt.
The mortgage, which in this case is a property, then comes in the form of a mortgaged mortgage deed.
When to invest in bonds?
You can own bonds if you think the stock market will decline for many years. Or if you think the policy rate will go down for many years.
Then your fixed coupon rate will be more attractive. Many investors and managers also choose to have 30% of their assets in bonds because it provides better risk diversification.
If you are young and have a long way to go until you retire, you should mainly own shares because over time, returns always yield better than bonds, and the risk decreases because you have so many years left before you need the money.
If you are under 40, you can invest in small companies that grow quickly. If the companies reinvest the profit, the interest on interest effect will work faster for you.
If you are a pensioner, bonds are a good idea because you can not afford to lose your money in old age.
Coupon interest from bonds is then good enough to pay bills and you can count on a fixed income every year.
If you know that you are going to buy a house in 5 years or that you are going to start studying again, it may be better to have the money in bonds, because you cannot afford to lose the cash contribution or the money that is set aside for studies.
Today, when the countries of the world have such low policy rates, government bonds and in some cases corporate bonds give a very low return.
Therefore, many small savers instead choose to invest in the best funds that provide better interest rates than bonds. If you think funds are too high risk, there are savings accounts with a deposit guarantee.
How high an interest rate can you get?
As there are bonds that have a maturity of several years, it is difficult to say exactly how much you can get in interest.
In addition, bonds often have a predetermined interest rate, which means that the price of a bond can change if the interest rate situation changes while the interest rate remains unchanged because it is fixed.
It is important to know that historical returns do not mean guaranteed future returns.
An investment in any form of securities, such as a bond, involves a certain amount of risk and you can never be sure of making a profit on, or getting back, your invested capital.
However, there are special rules regarding the interest rate for so-called high-cost loans. These rules mean, among other things, that
- The nominal interest rate may not exceed 40% above the reference rate
- The default interest rate may also not exceed 40% above the reference rate
- The total cost of the loan may be a maximum of the loan amount x 2 (times two)
It is also important to remember that both the level of risk and the level of return can vary, mainly depending on where the bond is purchased but also on the interest rate situation in the market.
Should the lender go bankrupt, you may also risk losing the entire investment.
If you are looking for another form of bond, you can instead buy a zero-coupon bond, which is a form of bond that runs without interest.
The easiest way is to compare these bonds with shares that provide returns on the same day as they are sold.
Save in bonds as a private individual
If you as an individual want to buy and save in bonds, there are mainly two different types of bonds to choose from, namely premium bonds and corporate bonds.
Basically, they are structured in basically the same way, even if they are covered by slightly different conditions.
Both bonds are distributed over a fixed period of time, a so-called maturity. The maturity can vary depending on who issues the bonds and the type of bonds in question.
Common to these bonds is that they are covered by a predetermined end date which also defines the end of the maturity. This way you know from the beginning when you will get your money paid out.
As a private individual, you have a lot to gain from investing in bonds. This means, for example, a small risk of saving in bonds compared with, for example, shares, as you get back your investments in connection with the maturity expiring.
The money you invest is also not tied up, which means an opportunity for you to sell bonds before the maturity expires. However, bonds generally provide lower relief than equities.
Good concept to keep track of for those who want to save in bonds:
- Nominal value: the money you get back in connection with the bond maturing
- Coupon: the interest you receive for lending money
- Due date: the date on which the nominal value is repaid
- Issuer: the company issuing the bonds
Bonds are thus a loan and nothing else.
It can be companies or the state that issue these and that borrow money from those who own the bond. The company or the state then pays interest to the owner of the bond.
For large organizations such as companies and governments, bonds are used as financing methods. Market trading takes place in large amounts and pricing takes place as a percentage of the original value.
Today, when the countries of the world have such low interest rates, bonds give a low return.
Therefore, many choose to instead invest their money in savings accounts that provide better interest rates than bonds.
Good luck with your investments!