Bonds can provide a stable source of income and can protect the money you invest. They are considered less risky than growth assets like shares and property, and can help to diversify your investment portfolio.
What is a bond
When you invest in bonds, you're lending money to a company or government. In return, you get regular interest payments, called coupon payments.
Bonds are generally viewed as a defensive asset and considered to be lower risk. They are still exposed to:
- Interest rate risk – the risk that a change in interest rates could reduce the market value of the bond. If interest rates rise, bonds offering lower coupon payment rates become less attractive investments
- Credit risk – the risk that the issuer could default or go insolvent
All bonds have a set value, called ‘face value’, when first issued. If you hold the bond until maturity, you get back the face value (or principal) of the bond.
If you sell a bond before maturity, you’ll get the market value. This could be lower than the face value. Market value is influenced by:
- interest rate movements
- credit risk of the issuer
- level of liquidity, and
- when the bond is due to be paid back
Watch out for imposter bond investment offers. Scammers pretend to be from well-known domestic or international financial service firms and offer high yield bond investments.
How to buy and sell bonds
The main issuers of bonds in Australia are the Australian Government and corporates. Always read the financial services guide and product disclosure statement (PDS) before you invest.
Government Bonds
There are two types of Government bonds: Australian Government Bonds (AGBs) and Semi Government Bonds (Semis).
Australian Government Bonds (AGBs)
AGBs (also known as Treasury Bonds) represent sovereign debt issued by the Australian government. They guarantee a rate of return if held until maturity.
Exchanged-traded Treasury Bonds (eTBs) give fixed interest payments. Exchange-traded Treasury Indexed Bonds (eTIBs) give interest payments linked to inflation.
You can buy and sell listed AGBs on the Australian Securities Exchange (ASX) at market value. You must pay any brokerage fees.
To find out more, take the ASX online Government Bonds course.
Semi Government Bonds (Semis)
Semis represent semi sovereign debt issued by Australian states and territories. They can only be bought and sold through state and territory treasury corporations.
Corporate bonds
A corporate bond is a way for a company to raise money from investors to finance its business activities.
Consider the credit risk of corporate bonds before you buy. If the company goes out of business, you won't get coupon payments and may not get your face value back.
Corporate bonds are primarily issued and traded on the over-the-counter (OTC) market. The minimum amount required to buy corporate bonds is typically large, up to $500,000.
Before you invest in a corporate bond
It is rare for corporate bonds to be issued to the retail market (allowing purchases below $500,000). If someone offers you a corporate bond be wary as it could be a scam.
For any corporate bond offer, check:
- Is the prospectus lodged on ASIC’s offer notice board? If not, it is likely a scam.
- Is the offer or prospectus from a legitimate source? If you’re not sure, go to the issuer’s website to download the prospectus and application form (with bank account details).
- Is the bond available to you? Some bonds, such as green bonds , are not available unless purchased in a managed fund. Be cautious if someone offers you these types of investments.
Reasons to invest in bonds
The main reasons people invest in bonds are:
Stable income stream
Bonds pay interest (coupon payments) at regular intervals and can provide a stable and predictable income stream. The interest rate you can earn on a bond may be higher than a savings account or term deposit. Some bonds, especially government bonds, also have high liquidity, meaning they're easy to sell if you need to free up money quickly.
Lower risk
Bonds are defensive investments and lower risk than growth investments like shares or property.
The amount of risk depends on the issuer of the bond: either the Australian Government (lowest risk) or a company (higher risk).
Diversify your portfolio
Bonds are often used to diversify a portfolio. Diversification lowers the risk in a portfolio because no matter what the economy does, some investments are likely to benefit. For example, when interest rates fall, bond prices rise, while shares often fall at this time.
Issuers of bonds
There are two issuers of bonds in Australia:
- the Australian Government
- Companies
All bonds have a set value (called the face value) when they are first issued. This is how much you pay for the bond (usually $100 or $1,000). It is the amount you get back if you hold a bond until maturity.
Australian Government Bonds (AGBs)
AGBs are the safest type of bonds. If you buy and hold them to maturity, you're guaranteed a rate of return.
You can buy and sell government bonds on the Australian Securities Exchange (ASX) at market value. This may be higher or lower than the face value. You will also pay any brokerage fees.
To find out more, visit the:
Corporate bonds
Corporate bonds are riskier than AGBs. If the company goes out of business, you won't get coupon payments and may not get your principal back. To compensate for this, corporate bonds offer higher coupon payments than Government bonds.
But, bond are still less risky than shares. This is because if a company collapses, bonds holders are paid out before shareholders.
You can buy corporate bonds directly from the issuer through a public offer (known as the primary market) at face value. You can also buy some corporate bonds on the ASX after they have been in the primary market (known as the secondary market).
Read the prospectus or 'term sheet' to understand the risks and credit worthiness of the company before investing in bonds.
Investing in corporate bonds
Use our guide to understand corporate bonds, and balance the risks against the return.
Interest on bonds
When you invest in bonds, you earn interest on the face value. You get this paid regularly as coupon payments.
There are three types of interest you can get paid:
Fixed rate
The interest rate is set when the bond is issued and it stays the same until maturity.
With fixed rate bonds, you get:
- fixed coupon payments
- face value returned to you if you hold it to maturity
Generally, people invest in fixed rate bonds for a stable, regular income stream and to diversify their portfolio.
Floating rate
The interest rate can go up or down over the term of the bond. The coupon rate you get is based on an underlying interest rate plus a specified percentage or margin (for example, the cash rate + 2%).
With floating rate bonds, you get:
- coupon payments — they'll rise if interest rates go up, but fall if interest rates go down
- face value returned to you if you hold it to maturity
Floating rate bonds help you get a stable income and protect your returns if interest rates rise.
Indexed
Indexed bonds protect against rising inflation, measured by the consumer price index (CPI).
Both coupon payments and the face value increase in line with changes in the CPI.
Investors use indexed bonds to earn a return that increases with inflation (which can reduce your returns) and diversify a portfolio.
Risk of selling before maturity
If you buy a bond and hold it to maturity, you'll get back the face value. But if you sell a bond before maturity, you'll get market value. This can be more or less than the face value.
The market value (price) of a bond depends on supply and demand. Market interest rates have the biggest impact on the price of bonds. The credit risk of the issuer and how long the bond is issued for (duration) can also have a big impact on the price of a bond.
The price of fixed rate bonds and indexed bonds moves in the opposite direction to market interest rates:
- If market interest rates rise, the price of these bonds falls.
- If market interest rates fall, the price of these bonds rises.
The price of floating rate bonds doesn't move very much when interest rates change because their coupon payment rate adjusts.
Some bonds can be hard to sell. If you're planning to sell before maturity, look for bonds with high liquidity, for example, AGBs.
Working out the value of a bond
Yield to maturity (YTM) is the best measure of the value of a bond. It is also a good way to compare what you'll get by investing in different bonds.
YTM calculates the average annual return of a bond from when you buy it (at market value) until maturity. It assumes that you reinvest coupon payments in the bond at the same interest rate the bond is earning.
Bear in mind that YTM doesn't assess the risks of particular bonds (such as credit risk). Balance the return you can get against any risks before you make an investment decision.
Calculate the YTM of a bond you're looking to invest in.
Pablo avoids an imposter bond scam
Pablo is looking for somewhere safe to invest the money from the recent sale of his house. He searches online using the term “best high yield investment” and finds an investment comparison website.
He completes an online enquiry form on the website. Someone claiming to be from a well-known bank contacts him. This person offers Pablo “high-interest treasury bonds”. They say the bonds have a 5-year term, a fixed interest rate of 6%, and is price-protected under a government scheme. They email Pablo a prospectus.
Pablo notices that the email is not from a bank email address. He checks ASIC’s Offer Notice Board to see if the prospectus is registered with ASIC. He doesn’t find it. He then looks up the bank’s website for more information and discovers a warning about imposter bond scams.
Pablo decides not to invest with this person and blocks their calls. He reports them to ASIC.