Bonds represent potentially one of the lowest risk forms of investment in the market, particularly if high grade government bonds are purchased or other bonds issued with an investment grade rating. As such, the inclusion of a proportion of bonds may be a wise choice for every diversified investment portfolio.
Buying and Selling Bonds: What are Bonds?
Bonds are simply a form of long term debt issued by a government or company however, instead of going to a bank or financial institution the bond issuer goes directly to the public to raise money in the form of a bond.
Bonds are issued with a par value, this is the amount of money which the buyer effectively loans the issuer. In addition, each bond will be issued with a coupon rate representing the interest rate the lender will receive at fixed intervals until the date of maturity. On maturity, the bond issuer will pay back the par value of the bond to the lender and coupon payments will cease.
From a risk perspective, bonds often represent one of the lowest risk investments available. Should a company get into financial difficulties, bond holders will have a claim on the assets of a company before that of the shareholder. Despite the low risk nature of bonds, no investment is completely risk free and bond holders do face the risk of default on both government and corporate bonds.
Buying and Selling Bonds: Ways to Invest in Bonds
The buying and selling of bonds is a relatively simple process however, there are a number of ways in which the potential investor can gain an exposure to bonds, here are some of the most popular:
- Direct Trading – Perhaps the most obvious way to invest in bonds is through direct trading, here one can either consider purchasing new bonds at the point of issue. Otherwise bonds may be purchased on the secondary market through the services of a stock broker.
- Bond ETF – One issue with the trading of bonds is the potential illiquid nature of the market, bond ETFs seek to give the investor a way of trading bonds without running into such problems. Bond ETFs are essentially an investment in a group of bonds which are highly liquid and thus instantly tradable on the secondary markets. Bond ETFs come in a range of themes and guises covering corporate and government bonds however, bond ETFs will always cover highly tradable bonds as opposed to obscure bond issues.
- Bond Unit Trusts – This is a way of investing in a diversified portfolio of bonds. Here a fund manager will buy a portfolio of bonds which are then broken down into units and sold to investors. Unit trusts may be a good way of gaining an exposure to higher risk bonds such as junk bonds without taking the risk of investing in a single low grade bond.
In summary, bonds represent a potentially low risk option for investment and should be considered as a key part of any investment portfolio. There are however, a wide number of options available enabling an investor to gain an exposure to the bond markets, each of which should be researched thoroughly.