Bonds can be bought when issued, or can be bought from other investors. Global bond markets are twice the size of global sharemarkets and millions of bonds are traded daily around the world.
Good quality bonds are therefore liquid – easy access to your money, an excellent feature - bonds can be bought and sold readily in most cases, sometimes for less the you paid for them, and sometimes more. The big thing is you are not locked in.
- Plain and simple (vanilla) bonds paying a fixed rate for 5 years, and then repaid.
- Bonds issued that do not mature for 10 or even 20 years, with provisions every 5 years to reset the interest rate, and sometimes repay early.
- Some bonds are perpetual, reset the rate annually or every 5 years, and never mature.
As with all investments there are very good bonds , good bonds, average bonds, and junk bonds. Ratings might be AAA, AA, A, BBB, BB or B, and anything higher than BBB is investment grade.
AAA is the lowest risk, followed by AA and so on.
Some examples of NZ ratings and interest rates, currently extremely low ;
If you want a “safe haven”, you must seek quality first, and put the interest rate second.
Why do most bonds pay more than bank rates?
Bond rates are set by;
Supply and demand – currently (2012) bond rates are low because bank rates are very low and a lot of money is seeking a better interest rate.
Risk - bonds can be very low risk to high risk. Accordingly low risk bonds need to offer a little more than the banks to attract investors, and high risk bonds a lot more.
Term - investors usually demand a higher rate for a longer term, and most bonds are for 5 years, or sometimes longer.
If you need to sell your bond before maturity the price can vary. The huge global bond market sets the price of all bonds depending on many factors, but generally speaking ;
- a bond value will ease if interest rates rose since you bought the bond
- a bond value will rise if interest rates fell since you bought the bond
However if you hold to maturity you will be repaid in full.
Note that perpetuals never mature, and so the price will be set by the market at all times.
After the 1929 crash the US govt set up various committees to report to the American public about how to invest and never again lose so much money. The report came up with four main points that are still valid today:
- Buy quality investments
- Diversify widely onshore & offshore
- Get independent advice
- Average into shares over time ( i.e. buy shares progressively)
These key points are still very much valid when investing today.