How can you invest in bonds?
Investing in bonds can be interesting for an investor looking for a relatively safe investment. In this article we discuss how you can make money with bonds. In this beginner’s guide to bond investing you learn everything you need to know to start!
What are bonds?
Bonds are loans issued by, for example, a company or government. When you buy a bond, you lend money to that organization. In return, you will usually receive interest. This interest is also called coupon rate.
How can you invest in bonds?
Are you considering an investment in bonds but don't know how to do it? You will feel right at home on this page. We briefly discuss the various ways in which you can invest in bonds.
How to buy bonds?
The most direct way to invest in bonds is by simply buying them. You can buy bonds by using an online broker. A broker is a party that can buy and sell financial securities for you. You can directly open an account with a reliable broker:
|Invest in stocks without commissions! Other costs applicable.
|Speculate on price increases and decreases with a free demo!
|Invest in stocks & ETF's against low fees.
|Actively speculate in shares by using CFD's. 82% of retail CFD accounts lose money.
|Compare the best brokers & open a free demo!
Buying a bond through DEGIRO is easy. Via the search field you first select the bond you want to buy. After you found the bond you want to invest in, you can place a market order. With a market order, you buy the bond directly at the best available price. Do you only want to buy the bond at a certain price? Then you have to use a limit order.
Subscribing to bonds
Not all bonds are tradable through a broker. Many bonds are issued directly by an institution to raise money. For example, a property developer may issue bonds to raise enough money for a new construction project.
When this is the case you sign up for a new bond issue. When you do this, you will receive the number of bonds you want to buy at the offer price. Do additional research when you subscribe to an issue from an unknown party. When the body behind the bond goes bankrupt, you will lose all your money.
Investing in ETFs
Even with bonds it can be wise to diversify as much as possible. You can do this by buying ETFs or exchange-traded funds. These are funds that invest investors' money in a collection of bonds. This allows you to buy a selection of bonds directly with a relatively small amount of money. When you buy an ETF, it is important to investigate whether there is sufficient diversification across bonds. Not all ETFs buy various bonds.
The best broker to invest in ETFs is DEGIRO. At DEGIRO, you pay low transaction fees when you invest in ETF’s. This allows you to achieve a higher yield. Use the button below to directly open a free demo account:
In which European bond funds can you invest?
- iShares Core € Govt Bond UCITS ETF: This Fund tracks the yield on government bonds of countries within the Eurozone.
- De Think iBoxx Government Bond UCITS ETF (TGBT): This fund also tracks government bonds, 25 in total. The objective is to follow the Market iBoxx EUR Liquid Sovereign Diversified 1-10 Index.
- De Think iBoxx AAA-AA Government Bond UCITS ETF (TAT): This fund tracks government bonds with a minimum rating of AA and seeks to track the Markit iBoxx EUR Liquid Sovereign Capped AAA-AA 1-5 Index.
- De Think iBoxx AAA-AA Government Bond UCITS ETF (TAT): This ETF also tracks government bonds, but this time with at least an AA rating. The objective of the fund is to track the Markit iBoxx EUR Liquid Sovereign Capped AAA-AA 1-5 Index.
Funds investing in corporate bonds
- iShares € Aggregate Bond UCITS ETF (IEAG): this fund tracks government bonds & corporate bonds issued in euros that are relatively safe.
- De iShares Core € Corp Bond USCITS ETF (IEAA): this fund follows well rated corporate bonds issued in euros.
De iShares $ Treasury Bond 1-3yr UCITS ETF (LBTE): this fund is denominated in dollars and includes U.S. government bonds with a duration of one to three years.
What do you want to know about bonds?
- Make money: how do you make money with bonds?
- Bonds background: how do bonds function?
- Interest: how is the interest on a bond determined?
- Bond price: how is the price of a bond determined?
- Risks: what are the risks of investing in bonds?
- Types: what types of bonds exist?
- Example: how does investing in bonds work?
- Advantages: what are the benefits of bonds?
- Wise investing: should you actually invest in bonds?
- Safety: how safe is investing in bonds?
- Differences: how are bonds different from shares?
When you invest in bonds, you obviously want to achieve a positive return. There are two ways in which you can make money with bonds.
1: exchange rate gain
The prices of bonds are constantly fluctuating. Most bonds are freely tradable and the game of supply and demand creates a price. If you buy the bond at the right time, you can achieve a positive return by selling it for a higher price.
2: interest payments
On most bonds you will receive interest payments. Periodically, you will receive a fixed amount of interest. When you invest money in bonds, you can thus build up a fixed and fairly certain income from your investments. Alternatively, you can do this by investing in stocks that pay out substantial dividends.
Bonds are a smart way for companies and governments to raise money. As early as 1624, the Dutch water board issued the first bond with a value of 1,200 Dutch guilders. Even now, holders of this perpetual bond still regularly receive an amount of interest. The basic principle of the bond has changed little over the years.
When a company wants to raise money, they write out a bond. Bonds can be issued over different periods of time. The duration indicates after how many years the amount of the loan will be repaid. If the term is 10 years, you will get the total amount lent back at the end of those 10 years.
Interest rates can differ widely. Not every bond will pay the same percentage of interest. The moments at which interest is paid also differ. Finally, the issuer determines the market value of the bond. This does not always happen at the nominal value of the bond. The nominal value is the amount redeemed at the end of the term. The options are:
- At par: at 100% of the nominal value
- Under par: issued for less than 100% of the nominal value
- Over par: issued for more than 100% of the nominal value
Companies and governments can determine how much interest they give on a bond. However, if they provide an unattractive interest rate, no one will buy the bond. The interest rate will therefore always depend on the situation of the market. Below, we discuss three factors that influence the interest rate on bonds.
The market interest rate
The central banks determine the market interest rate at which banks can borrow money. This interest rate then indirectly determines how much interest people receive on their savings account. When the market interest rate is high, the interest rate on a bond will have to be even higher. After all, bonds are investment products with some risk. If, on the other hand, the interest rate is low, then the interest rate on bonds will also be lower.
Duration of the loan
When you go to the bank and want to borrow money, the interest rate increases when you want to do this for a longer period of time. After all, there is a greater chance that the interest rate will rise in the meantime and then the lender has a disadvantage. The same principle applies to bonds. When the term is longer, you'll receive a higher amount of interest. Only in the exceptional situation of a reverse interest curve, this is not the case.
A final important factor in determining the interest rate on a bond is its creditworthiness. There is always a small chance that the counterparty will not be able to repay the amount of the loan. With some bonds, this risk is minuscule: think for example of bonds issued by the government. Corporate bonds, on the other hand, are more risky. Bonds with a lower credit rating have a higher interest rate. In this way, you are compensated for the higher risk.
Bonds are traded on the stock exchange at market price. This price is different from the price at which the bonds were originally issued. The attractiveness of a bond depends strongly on the market interest rate.
When the market interest rate rises, the prices of the outstanding bonds fall. The new bonds that are issued are then more attractive because the interest rate on them is higher.
If, on the other hand, the market interest rate falls, the prices of the outstanding bonds rise. The current bonds then pay more interest than the bonds that are currently being issued. You will then receive a higher annual interest payment than the market rate.
The term to maturity also has a role in how strongly the prices of bonds fluctuate. If the term is longer, the price of the bond will move more when the market interest rate changes. After all, the influence of the interest rate change is stronger in that case. With a longer term to maturity, a higher or lower amount of interest is paid periodically for a longer period of time.
Investing in bonds involves the necessary risks. The most important risks of investing in a bond are the interest rate risk, the debtor risk and the market risk. Let's take a brief look at what these types of risks are.
Interest rate risk is the risk that market interest rates rise. The interest rate on a bond remains the same throughout its term. When the market interest rate rises, the bond becomes less attractive. As a result, the price of the bond will fall. The return on your investment then decreases.
The debtor or counterparty risk relates to the creditworthiness of the issuer of the bond. In the unlikely event that the counterparty goes bankrupt, you may lose the full amount of your deposit. Fortunately, this seldom happens, especially with the safer bonds.
Depending on the market situation, the demand for bonds may decline. This happens, for example, when other investment products yield a much higher return on average. When there is less demand for bonds, the price will fall.
There are different types of bonds. Not every type of bond is equally risky. We can split bonds into:
- Government bonds: these bonds are issued by a country.
- Corporate bonds: these bonds are issued by a company.
- High-yield bonds: bonds of uncreditworthy companies at high-interest rates.
- Emerging market debt: bonds of companies & governments from emerging countries.
Government bonds carry little or no risk, while emerging market debt carries high risks. The differences in the interest you receive are therefore large. On the safest bonds you sometimes have to pay interest, while on the most dangerous bonds you sometimes receive as much as 9 or 10 percent interest per year.
You can read the creditworthiness of a bond by looking at its rating. The rating indicates how creditworthy a bond is. Companies such as Standard & Poor's and Fitch indicate with letters how creditworthy a bond is. Bonds with a rating of AAA are the safest and bonds with a rating of D are very risky. Before investing in a bond, it is wise to check the creditworthiness of the bond.
What types of bonds are there?
Most people invest in fixed yield bonds. With this type of bond, you periodically receive fixed interest payments. However, bonds come in all shapes and sizes. Let's look at some other types of bonds you can invest in.
This type of bond is issued by a company. With a convertible bond, you as an investor will not receive your money back at the end of the term. Instead, you receive a fixed number of shares per bond. It is especially interesting to invest in convertible bonds when you have a lot of confidence in the share price of the company.
Zero coupon bond
This type of bond does not pay interest. The price for this type of bond is therefore lower than the amount you receive at the end of the term. The return then consists of the difference between the purchase price of the bond and the amount you receive on the expiration date.
Subordinated bonds are riskier than 'normal bonds'. With a subordinated bond, you only receive your money in the event of a company's bankruptcy after all normal bondholders have received their money. For this higher risk, you usually receive a higher interest rate.
With this type of bond, the interest rate moves with inflation. As a result, the risk for the investor is somewhat lower. However, as an investor you are paid to take risks. The return will therefore be lower with this type of bond.
Floating interest rate bond
The interest rate is not fixed for this type of bond. For example, the interest rate can move with the market rate. Pay close attention when you buy this type of bond and examine whether it is likely that the interest rate will move in the right direction. If this is not the case, it is better to buy another bond.
Speculating with bonds
Bonds often have a safe image. This certainly does not have to be the case. For the more adventurous investor, there are the high-yield bonds or junk bonds. With an assessment below BBB, the risk of bankruptcy is much higher. As an investor, you will receive a much higher interest percentage for these riskier types of bonds.
Before investing in these types of risky bonds, it is important to research the company carefully. After all, when the business goes bankrupt, you can lose the full amount of your investment.
Nowadays, bonds with a negative return also exist. You have to pay money to hold a bond.
Investors are still buying this bond because they expect the interest rate to fall even further. The price of these bonds will then increase, making it still possible to achieve a positive return.
However, I would never invest in anything that requires me to pay money. I would rather invest my money in some riskier shares instead.
By using an example, we show how investing on the bond market works. In the first example, we want to buy a bond of a fictitious company. The interest rate is 5%. We buy the bond and receive an interest payment of 5% each month. After we buy the bond some negative news is published: the company appears to be almost bankrupt. People sell their bonds en masse because they are afraid to lose their entire investment.
Despite the fact that people are selling the bonds, we still receive the 5% interest every month. In the end, the company manages to recover and at the end of the term we receive back the amount we originally invested.
In the second example, we buy bonds during the corona crisis. We decide to invest in government bonds, as there is a lot of uncertainty. The central banks lower the interest rate, so you would expect the interest rate on the bonds to drop. However, this turns out differently. People are afraid of the outcome of the crisis, which causes the interest rate on the bonds to rise sharply. We buy governmental bonds with a higher interest rate, and we hope to achieve a good return on this in the future.
As you can see, there are many factors that play a role when investing in bonds. The price of a bond is certainly not the only factor that is important. The interest you receive on the bond can also be an important consideration. When the interest rate is high, you can use bonds to build up a nice fixed income.
An important tip when investing in bonds is to ensure sufficient diversification. When you buy bonds from companies, it is wise to do this in different sectors. A rising oil price, for example, can be beneficial for a company like Shell and disastrous for a company like Air France-KLM. The prices of bonds on Shell may rise while those of a company like Air France-KLM fall.
It is also advisable to diversify between different investment products. When bonds do well, shares often perform worse. This also applies the other way around. By investing in both shares and bonds, you ensure a more stable and secure return. Would you like to know more about investing in shares? Read our article on this subject:
Investing in bonds can be advantageous for several reasons. Let's see what the biggest advantages of bonds are:
It's relatively safe
Bonds are a relatively safe investment. The price of a bond often moves less strongly than the price of a share. Moreover, even if the price is lower, you will still receive the same amount of interest.
You receive an income
On bonds, you will receive a periodic payment in interest. This allows you to build up an extra income with which you can do nice things again.
By investing in bonds, you can spread the risks of your entire investment portfolio. Shares perform better in the long term. However, this certainly does not have to be the case in the short term. By also investing in bonds, you reduce the volatility of your total portfolio.
Whether it is wise to invest in bonds strongly depends on your personal situation. Bonds are a relatively safe and defensive investment product. Bonds are therefore more popular for older investors. When your retirement is approaching and your time horizon is shorter, you want to have a fixed amount of money at your disposal. By investing in bonds, you are almost certain that you will get a certain amount back at the end of the term.
However, share prices fluctuate sharply. It is therefore not at all certain that you will have the amount of your investment back in a few years’ time. Therefore, shares are more suitable for investors who have time. Over a longer period of time, shares yield a lot better than bonds.
That's why you should consider for yourself to what extent you're willing to take risks. If you have more time, and you want to take more risks, then you can invest a larger part of your money in shares.
When you decide to invest in bonds, it can be interesting to build up a bond ladder. You then invest your money in bonds with different maturities. You can invest part of your money in a bond that expires over 5 years and another part in a bond that expires over 10 years.
When the market interest rate rises, this prevents all your money from being trapped in the same bond for a longer period of time. After 5 years, you can invest part of your money somewhere else.
Of course, investing is never completely safe. After all, as an investor, you get paid to take risks. Nevertheless, if you take a smart approach, you can invest much more safely in bonds.
It is important to first choose a good party to buy bonds. Do not invest with rogue companies: if you do this, there is a chance that you will lose the entire amount of your investment to a crook. In our brokers comparison overview, you can immediately see where you can invest reliably.
It is also important to investigate the creditworthiness of the company properly. If a company has a good score, this is already a good indication for a safe investment. However, dig a little deeper and investigate what the party behind the bond is doing. Rating companies sometimes get it wrong too. A good example of this are their positive ratings for the mortgage bonds that ultimately caused the 2008 credit crisis.
Which bonds are interesting?
This is a question we cannot answer directly. If you are willing to take large risks, then an investment in a high-yield bond can be interesting. If you are looking for a very safe investment, you may consider investing in a government bond.
In any case, it is wise to perform proper research into the market situation. First predict what you think will happen to the market interest rate. After all, the market interest rate has a strong influence on the prices of bonds.
When you think that the market interest rate is going to fall, it is even more interesting to buy bonds. If you think that the market interest rate is going to rise, then it might be better to wait awhile before you buy bonds.
Bonds and shares are the best-known investment products out there. Not everyone understands the difference between a bond and a stock. When you buy a share, you immediately become co-owner of the company. You can take part in the shareholders' meeting, and you have the right to receive part of the profits in the form of dividends.
When you buy a bond, you are not a co-owner of the company. Therefore, you are not welcome at the company's meeting, and you do not receive any dividends. You are only entitled to interest payments and at the end of the term your bond expires automatically. However, in the event of bankruptcy, you are entitled to money before the shareholders receive it. This makes a bond less risky.
Try trading risk free?
How to buy bonds and make money from them?
Are you curious about the best method for buying bonds? In this article we will discuss the best method to invest in bonds. This way you will immediately discover the various ways in which you can make money with bonds. What are bonds? Bonds are debt securities issued by a company (corporate bond) or government … [Lees meer]
How to make profits with bonds? Yield explained
Investing in bonds can be an attractive choice if you do not want to run too much risk. In this article we will discuss how bond investing works. How is the price of a bond actually established, and how can you determine the profit you make with your bond? What are bonds? Bonds are debt … [Lees meer]
What are bonds?
Are you wondering what bonds are? Then you have arrived at the right place! In this article we describe the meaning of a bond in detail. What are bonds? A bond is a loan issued by the government or by a company. Bonds are debt securities. When you buy a bond, you usually receive a … [Lees meer]
What are the risks of bonds?
As an investor, you are of course always looking for a form of investment that gives a high return, but which is also safe. An example of a relatively safe investment is the bond. For a long time, many investors thought investing in government bonds was a safe haven. But do bonds and government bonds … [Lees meer]
How to make profits with bonds? Yield explained
Investing in bonds can be an attractive choice if you do not want to run too much risk. In this article we will discuss how bond investing works. How is the price of a bond actually established, and how can you determine the profit you make with your bond?
What are bonds?
Bonds are debt securities. When you buy a bond from a company or the government, you are entitled to periodic interest payments. With a bond, these different characteristics are important:
- Coupon rate: the amount of interest you receive when you buy the bond.
- Maturity date: the last day of the bond’s validity.
- Denominations: the value in which you can purchase the bond.
- Currency of issue: the exchange rate can determine your return.
- Issue price: the price at which the bond is issued.
In the article what is a bond you can read in more detail what bonds are and how they work. You can also read more about the different types of bonds.
How can you invest in bonds?
You can easily invest in bonds at an online broker. Bonds are generally traded freely. The price of a bond need not be the same as the issue price. The price of a bond can change due to the influence of supply and demand. Click here to see at which brokers you can invest in bonds.
A good broker for trading bonds is DEGIRO. At DEGIRO you can buy and sell bonds at favourable rates. Use the button to open an account at DEGIRO:
Some bonds are not freely tradable. For example, some companies allow you to subscribe to bonds. Be aware of the risks: not all bonds always pay out.
What is the return on a bond investment?
The return that you achieve on your bond investment depends very much on your investment strategy. Of course, you can choose to buy a bond when the price is low and then sell it at a profit. When you choose this option, your profit consists of the price gain.
Most people who invest in bonds focus mainly on the interest payments. The interest percentage you receive on a bond is also called the yield. When the yield is 5 percent, you will receive an annual return of 5 percent over your bond. If the bond has a value of $1000, you will receive $50 annually for your investment.
It is important to distinguish between your nominal and real return. If inflation is 2 percent, you can buy 2 percent less products with the same $1000 over a year. Your real return on your bond is then 3 percent.
It is also smart to compare your bond investment with other investment products. When interest rates on bonds rise, you might have achieved a 7 percent return with a new bond. In this case, you do make a profit in absolute terms, but in relative terms you would have been better off making another investment.
Finally, you must also take into account the purchase price of a bond. When a bond pays out a high yield, the price can rise above the nominal value. For example, if you have to pay 105% of the value, you pay a premium of 5%. At the end of the term, you will only receive the original purchase price of 100% back. Your return is then, despite the high-interest payments, immediately much lower.
Relatively safe investment in bonds
The price of a bond can change continuously. Yet, this does not have to be a problem. You can choose to buy bonds and hold them during the term. At the end of the term you will receive the full amount back. In this way, the price of the bond does not affect your return.
However, it is also possible to actively trade bonds. This way you can make price gains. But before you do this, you must understand the factors that can influence the price of a bond.
What determines the price of a bond?
The nominal value is the value at which the bond was originally issued. The price of the bond may subsequently rise above or fall below the nominal value. The value of a bond is determined by, among other things, the market interest rate, credit rating and the remaining term to maturity.
The effect of market interest rates on the price
The market interest rate has the greatest influence on the price of a bond. The interest on a bond is fixed. If you bought a thirty-year bond some time ago with an interest rate of eight per cent, you will always receive this eight per cent. However, the European Bank regularly adjusts the interest rate to stimulate the economy. A lower interest rate will counteract saving behaviour and will stimulate spending.
When the interest rate falls, and you own a bond with a higher interest rate than the market rate, the value of the bond will rise. The return on your bond in relation to the return on a savings account will then increase.
If you have a bond with a return of 8 percent and the market interest rate is 3 percent, this means that for every $1000 you earn $50 extra with your bond on an annual basis. You can then decide to sell the bond with a price profit or to keep the bond.
A rising interest rate will actually have a negative impact on the value of a bond. When the market interest rate rises, the interest on your bond is relatively lower. It is therefore important to estimate the future interest when you start investing in bonds. When you estimate the future interest correctly, you can make a nice profit with your investment in bonds!
Market interest rates and bond prices move in opposite directions
The creditworthiness of the institution behind the bond also plays a role in the price development. When you buy a bond, you run the risk of bankruptcy of the institution behind the bond. If this is the case, you lose your entire investment. When the company or the government behind the bond is seen as less risky, the price of the bond rises.
This was clearly reflected in the debt crisis in Greece, for example. The financial markets wondered whether Greece could still pay off its debts. Under the influence of these concerns about its creditworthiness, the value of Greek bonds fell sharply.
When you start investing in bonds, you can try to estimate the creditworthiness of countries and companies. In case of panic, the price of a bond sometimes drops quite extremely. This can be a good moment to buy!
Be extra careful when investing in bonds of parties who are not creditworthy. If the institution behind the bond goes bankrupt, you could lose the entire investment. Naturally, you will receive a higher interest rate on loans with a higher risk.
The remaining term also influences the price of a bond. For example, a bond with a higher interest rate and a longer term may have a higher price than a bond with a higher interest rate and a shorter term. This is because as a bondholder, you will probably benefit longer from the higher interest payments.
Should you invest in government bonds or corporate bonds?
When investing in bonds, you can choose between government bonds and corporate bonds. But what is the best investment? And what exactly is the difference?
Government bonds are generally seen as less risky. Governments are large and almost always manage to repay their debts in full. Certainly in large, stable economies such as Germany or the United States, the risk of not receiving your money back is almost zero.
Government bonds have little correlation or association with equities. Sometimes there is even an opposite relationship. When share prices rise, the prices of government bonds can decrease. Government bonds can therefore be a good investment to reduce the volatility of your portfolio. In bad economic times, you can still achieve a nice return.
Sovereign bond yields rose sharply as worries about sovereign debt repayment increased.
Corporate bonds are riskier, but tend to perform better over the long term. They also have a stronger correlation with the stock markets. When the economy performs badly, the prices of corporate bonds fall. When stock prices are performing well, the prices of corporate bonds rise.
This is because with corporate bonds, there is more concern about whether the lent amount will be repaid. After all, companies often go bankrupt and when this happens, you lose your entire investment. With corporate bonds, it is therefore even more important to check carefully whether the company behind the bond is performing well.
Bond investing: ensure diversification
As with any form of investment, it is also important with bonds to ensure sufficient diversification if you want to make a profit. Certainly, when you buy corporate bonds, this is important. When things go badly in one sector, it does not have to be bad in another sector. The correlation between bonds of companies in different sectors is therefore limited.
Ultimately, investing in bonds can be a good alternative to saving. After all, the return on savings is lower. A deposit could then be an alternative, but deposits do not have the flexibility that bonds have. However, never forget to do sufficient research. Bonds are less risky, but certainly not risk-free.
In our article Making Money Buying Bonds, we look at examples of how to get good results buying and selling bonds.
What are bonds?
Are you wondering what bonds are? Then you have arrived at the right place! In this article we describe the meaning of a bond in detail.
What are bonds?
A bond is a loan issued by the government or by a company. Bonds are debt securities. When you buy a bond, you usually receive a pre-agreed interest rate. It is also possible to trade actively in the value of bonds. On this page you can read what a bond is and what to look out for.
Bond explanation: what does a bond consist of?
A bond consists of several parts. The meaning of a bond can be deduced from this:
- Denomination: the amount of the bond.
- Interest: the interest you receive on the bond.
- Maturity: The period after which the bond is repaid.
A short explanation of bonds
- Bonds are debts issued by companies or governments.
- Bonds are by definition fixed income securities. This income is paid with interest.
- Bond prices move in the opposite direction of the interest rates. When interest rates increase, bond prices decrease. In contrast, when interest rates fall, bond prices increase.
- Bonds have an expiration date on which the nominal amount must be repaid. If this does not happen, the issuer can be declared bankrupt.
How does bond trading work?
Bond trading occurs through a primary and secondary market. On the primary market, the bonds are issued. This is often done through several banks in denominations of $1000, or a multiple thereof. The bonds intended for the private market are generally cheaper than those intended for institutional parties.
When you have bought a bond, you can usually trade it back on the secondary market. The price of a bond may fluctuate due to changes in market conditions. By buying and selling bonds at the right time, you can achieve a positive return.
The value of a bond
On the secondary market, a bond’s value can fluctuate. The face value can be $100, but it can be traded for $102. In this case, you pay 2% more than the amount you receive at the end of the term. This can happen when the market rate is lower than that of the bond.
What are the benefits of bonds?
Bonds are mainly bought by investors to bring more stability to their portfolio: the risks of bonds are much lower than the risks of shares. Only when the bond provider goes bankrupt, there a possibility that you will lose your money. In most cases, you will receive the agreed interest plus repayment.
A major disadvantage of investing in shares is the fact that there is no certainty. Prices can rise enormously but have also shown big declines in recent years. It is therefore wise to spread your risks as much as possible. By buying bonds you can compensate as much as possible for your losses in the case of falling stock prices.
How can you make a profit with bonds?
Most bonds pay interest, also known as the coupon rate. Typically, the coupon rate is paid on a monthly basis. This can be both a fixed and a variable percentage. Variable percentages, for example, are related to the height of EURIBOR. The interest is often paid once a year. If the bond had multiple owners within this period, the interest is distributed fairly.
In addition, it is possible to make a profit with bonds because the value of the bond increases. You can trade bonds freely just like shares. The price of bonds is determined by several factors. When market interest rates fall, the value of the bond usually increases. An improved credit rating of the issuer can also lead to a higher price. Finally, the price is also determined by supply and demand of the specific bond.
What kind of bonds are there?
The most common bond, is the ordinary bond. Normal bonds have no special characteristics.
When the party behind the bond goes bankrupt, you will receive your money later with a subordinated bond. The owners of regular bonds will be paid before you. Subordinated bonds are therefore riskier than normal bonds. Because of the higher risk, you typically receive more interest on the subordinated bond.
These are bonds with no predetermined maturity. These bonds are therefore not redeemed at any given time and can consequently remain open indefinitely. For some bonds, the company may still decide to repay the bond at a fixed price at a time.
Convertible bonds are bonds that can be converted into company shares. It is usually determined in advance how many shares you could receive for one bond.
This type of bond has no fixed rate. Their interest rates typically move along with market interest rates. The advantage of this bond is that you also get a higher yield with rising interest rates. However, falling interest rates reduce returns. Because the interest rate moves along with the market rate, the price of this type of bond is usually less volatile.
What is a zero-coupon bond?
A zero-coupon bond pays no interest. This bond is sold at a discount. At the end of the term, you as a bondholder will receive a larger sum of money back.
What is a callable bond?
A callable bond may be recalled before the expiration date. This type of bond is riskier for the investor. When the bond becomes more valuable because the market rate falls, the body behind the bond can buy it back.
What is a put bond?
A put bond or puttable bond is a bond that can be resold by the bond buyer. In this way, the bondholder can protect themselves from rising market interest rates. For the investor, there is a trade-off. You will receive a lower interest rate on this bond, but you are protected against increasing interest rates.
What are the risks of bonds?
Investing in bonds is also not fully risk-free. In this section of the article we discuss the risks of trading in bonds.
Creditworthiness of bonds
As with equities, each bond has a certain risk. This risk depends, among other things, on the creditworthiness of the lender, and it is therefore important to check whether the company or government behind the bond is in financial difficulty. The biggest risk of investing in bonds is not receiving the amount you lent at the end of the term due to bankruptcy.
Normally, governments are more creditworthy than companies. However, the recent debt crisis has shown that governments are sometimes unable to repay bonds. For example, bonds issued by the Greek government were not very safe at the time.
The interest rate risk
The development of market interest rates determines how attractive your bond investment is. When the market rate increases, the value of your bond decreases. It is more attractive for investors to buy new bonds, as they receive higher interest rates on the new bonds. When the interest rate increase, you risk getting paid less than you could have with a newer bond.
Over time, the value of your money decreases. This is because the price level is increasing: this is what we call inflation. At the end of the term of a bond, you will receive back the amount you have invested. However, this amount is worth less at the end of the term than at the beginning of the term. So, if interest rates don’t compensate for this, your real return can be negative.
In some cases, you may face a currency risk. This is the case when you buy a bond in a foreign currency. When your currency then drops in value, you can make a loss on your investment. Therefore, pay extra attention to investments in bonds listed in a foreign currency.
Conclusion risk and bond yield
The biggest risk of investing in bonds is not recovering the amount lent. Risk and return are always linked: when the risk of a bond is higher, the interest rate will also be higher. Therefore, investors are only willing to lend money if they receive compensation for the risk they are exposed to.
When you start buying bonds, you can use the credit worthiness report figures issued by agencies such as Standard & Poors, Moody’s and Fitch. An AAA status is very secure and a DDD status is very unsafe. In this way, you can assess and anticipate the risks of a bond. On the Standard & Poor website you can view current reviews of companies and governments.
Now you know exactly what bonds are. But do you also know how to invest in bonds? In the article investing in bonds we will take a closer look at investing in bonds.
What are the risks of bonds?
As an investor, you are of course always looking for a form of investment that gives a high return, but which is also safe. An example of a relatively safe investment is the bond. For a long time, many investors thought investing in government bonds was a safe haven. But do bonds and government bonds in particular have such a low risk?
What are the risks of bonds?
If the issuer of the bond is unable to repay the loan, then as a bondholder you have a problem. Even governments are not 100% infallible. As the owner of a bond, you therefore run the risk of losing your deposit. However, this risk is usually lower than for investments in shares.
Another risk of investing in bonds, is the fact that prices may change. This is especially important if you intend to buy and sell the bonds in the interim. After all, at the end of the term you get the nominal value back, regardless of the exact price.
You run a currency risk when you buy a bond in another currency. This is the case when you buy a bond noted in dollars for pounds. When the dollar falls in value, your interest payments in pounds decrease. The currency risk can therefore reduce your return.
Assessing the risk of a bond
You can often assess the risk of a bond by looking at its rating. A rating indicates how risky a bond is. A good rating indicates that the creditworthiness of a country or company is good and that you will probably get your money back. Bonds with a poorer rating often have a higher interest rate. After all, interest is the compensation for the risk you run!
What is a government bond?
A government bond is also referred to as a government loan. It is a bond issued by a government. In most countries government bonds are marketed by the Ministry of Finance. This agency attracts long-term and short-term loans to cover the government’s financing deficit.
Most government bonds have a term of ten years. However, there are also government bonds with shorter or longer maturities.
Return on government bonds
In recent years, real yields on many government bonds have become negative. Interest rates have fallen sharply. Interest usually compensates for the risk you run. Governments are seen as more stable than companies, which means that the interest rate is considerably lower. As a result, interest rates have fallen sharply under the influence of rising stock markets and low risks on government bonds.
When other investments yield less, the prices of bonds and government bonds rise again. During uncertain economic times, you can expect higher interest rates, as the risks are higher. Nevertheless, it is clear that other investment classes have become more popular compared to government bonds.
The end of the euro
Government bonds are not always a safe haven. This was already apparent in the debt crisis in which various European governments threatened to be unable to repay their debts.
Some economists philosophize about what will happen to the euro now that some European countries have been hit harder by the recession than others. This may lead to the temptation to return to their own currencies.
The turmoil in this period caused government bond yields to rise sharply. After all, the risks of government bonds increased considerably! Governments threatened to go bankrupt or were, in fact, already bankrupt: as a result, the prices of government bonds fell and the risk of bankruptcy for an entire government became increasingly realistic.
Are government bonds really that safe?
As we have seen in the past, there does appear to be a crack in the supposed safety of government bonds. Nevertheless, government bonds are still considerably safer compared to shares and corporate bonds. Periods of rise and fall alternate regularly in the financial world.
Long-term government bonds
Long-term government bonds in particular are risky if the financial climate becomes healthier. The current interest rate is in many cases so low, that the return to be achieved becomes negative when inflation increases. It is therefore risky to opt for long-term government bonds.
Short-term government bonds are therefore often the preferred choice for investors looking for a safe investment haven. Moreover, it is important to keep a close eye on the risk-measuring indicators on the stock market. As soon as the stock markets improve, the profitability of bonds often decreases.
How to buy bonds and make money from them?
Are you curious about the best method for buying bonds? In this article we will discuss the best method to invest in bonds. This way you will immediately discover the various ways in which you can make money with bonds.
What are bonds?
Bonds are debt securities issued by a company (corporate bond) or government (government bond). When the term of the bond expires, you will receive the amount of the bond back: this is also called the redemption value. Over the period that you hold the bond, you also receive an interest payment, which in the case of bonds is called the coupon rate.
Just like shares, bonds can be traded freely on the stock exchange. The prices of bonds may therefore fluctuate depending on the demand for the specific bond.
Where can you buy bonds?
If you want to make money buying and selling bonds, you first have to know where you can do this. You can easily trade bonds and bond funds at an online broker. There you can buy bonds of well-known companies and governments.
A good Dutch broker for buying bonds is DEGIRO. DEGIRO is a reliable broker where you can buy bonds at low rates. Moreover, at DEGIRO it is possible to trade in bond funds without buying and selling costs, when they are listed in the core selection. Use the button below to open an account at DEGIRO immediately:
What do you want to know about buying bonds?
- Methods: what ways are there to trade bonds?
- Understanding bonds: how to read a bond?
- Making money: how to make money with bonds?
- Timing: when is it smart to buy bonds?
- Types of bonds: what type of bond can you buy?
- Risks: what should you look out for when buying bonds?
- Price formation: how does the price of a bond come about?
You can choose to open individual bonds or invest in a fund that buys & sells bonds on your behalf.
Buying individual bonds
The first possibility to invest in bonds is to buy individual bonds. Bonds can be bought from most internet brokers whereby you pay transaction costs that are comparable to those you pay when buying shares. When buying individual bonds, it is important to pay attention to the term, current price, nominal value and interest rate.
Sometimes it is also possible to subscribe to an issue. You then receive the bonds at the issue price, which can be especially attractive when the bonds are issued below nominal value.
Investing in bonds with a mutual fund
It is also possible to invest in bonds with an investment fund. There are many possibilities within an investment fund. Often you can determine in which regions. Currencies, credit ratings, maturities and sectors you want to invest in. There is a taste for every investor. In this way, you do not buy the bond but a participation in the fund.
A major advantage of investing in bonds by means of a fund is that you can apply more diversification. It is often expensive to add spread to your bond portfolio on an individual basis. Government bonds are issued for a minimum of $1,000 and for corporate bonds this can rise to a minimum investment of $50,000. By applying diversification, you reduce the risks. The bankruptcy of one company, for example, does not immediately lead to the loss of the entire investment.
A disadvantage of an investment fund compared to buying bonds yourself is the fact that you often pay management costs. With individual bonds, you only pay the transaction costs. With a fund, however, you also have to pay the manager of the fund. This, of course, is at the expense of the ultimate return. If you have the capital to purchase the bonds individually, this may be the most advantageous choice.
Which option is best?
This depends entirely on your personal preferences and wishes. When you buy and select bonds yourself, you can decide which criteria you use. Moreover, buying individual bonds is cheaper than buying a participation in an investment fund: an investment fund charges management fees.
Yet, an investment fund can also be very attractive. Normally, bonds cost at least 1,000 pounds, but within an investment fund, you can already participate for a few pounds. In addition, you leave the difficult decisions out of your hands, which saves you time, and that is also worth something.
When you want to buy bonds, you must understand how to read a bond. A bond is often indicated in this way:
NL 0.75% 2027/07/15
The letters stand for the authority behind the bond. In this case, it is a government bond issued by the Dutch government. The percentage then indicates the coupon rate you receive and the date is the expiry date on which the amount is repaid. On every stock exchange, there is also a price for the bond.
This indicates how the value compares to the nominal value. The nominal value is indicated as 100 and this is the sum that you, as investor, will get back on the maturity date. So, in this case, this bond is trading at 4.03 per cent above its nominal value. Now you know what to look for before buying a bond.
Calculation example for a bond investment
Let’s use a mathematical example to show how an investment in a bond works. In this example, you decide to buy a government bond that pays coupon interest on 1 June and matures in 2 years. The price of the bond is currently 102%. The denomination is $1000 and the annual interest rate is 5%.
To purchase the bond, you now have to pay $1000 X 102% which comes down to $1020. At the end of the term, you will receive the nominal amount of $1000 back. Per year, you will also receive $50 in interest.
The coupon return in this case is $50 / $1020 (the amount you actually paid). This amounts to 4.9%. When the effective yield is taken into account, you also have to look at the remaining term. In 2 years’ time you receive twice $50 in interest which is $100. You do make a loss of $20 because you bought the bond for an amount higher than the nominal value.
In two years’ time, you will thus achieve a return of 8% and, on an annual basis, the effective return will be 4%. Before you buy a bond, it is important to calculate these numbers. That way you know whether it is wise to buy a bond.
If you want to make money by buying and selling bonds, you must understand what factors influence the price of a bond. These are mainly the market interest rate and the creditworthiness of the bond. In the article Investing in bonds you can read in more detail how the price of a bond is established.
The simplest way to make money by buying bonds is by holding them. This is because you receive interest on the bond and this amount is credited to your investment account every year. If you buy bonds at the beginning of the term for the interest, the price makes little difference as you will receive the full nominal amount back at the end of the term.
More active investors can choose to actively buy and sell bonds. If you do this well, you can make more money. It is important to predict the price movement of the bond. You do this by thinking about two things:
- Will the market interest rate increase or decrease in the future?
- Is the creditworthiness of this bond increasing or decreasing?
A falling market interest rate and a rising creditworthiness increase the price of a specific bond. By making good deliberations, you can buy the right bonds that will give you a good price return before maturity. Good luck with buying bonds!
When is it smart to buy bonds?
Depending on your investment strategy, it may be smart to buy bonds. For defensive investors it can be interesting to invest in bonds. Bonds are seen as relatively safe, because they are repaid at the end of the term. If the underlying party goes bankrupt, however, you can still lose your entire investment. But especially in the case of government bonds, the chance of this is minimal.
By buying bonds, you can also improve the risk diversification of your investments. By investing in different types of investment products, you reduce the chance of losing a lot of money when one investment category performs less well.
Bonds can be a good alternative for savings products. Especially when you have a large capital, these days you may even receive a negative interest rate on your savings.
The most secure bonds are government bonds: these are issued by the government. The chance that the government as a whole goes bankrupt is fairly small. Of course, this chance increases when you buy bonds from a less stable economy.
Bonds of high-quality companies with a good credit rating are also low risk. These bonds are also called investment grade and have a rating from AAA to BBB-.
You can also choose to buy bonds from less creditworthy companies. These bonds are popularly known as junk bonds or high-yield bonds. The interest on these bonds can quickly rise to ten percent or more, but there is also a greater chance of losing your deposit.
Buying bonds is safer than buying shares: this does not mean, however, that there are no risks associated with investing in bonds. The most obvious risk is the credit risk: if the party behind the bond goes bankrupt, you can often kiss your money goodbye.
There is also a price risk: because the price of a bond can rise and fall, your investment may be worth less. This is not a problem if you hold the bond until the end: you will still receive the original amount of the redemption value.
Another risk is a more technical one, namely the inflation risk. You receive a fixed payment in coupon interest and redemption, but the real value of this money may decrease. This happens when the general price level rises. You can then buy fewer products or services with the same amount of money.
Finally, when you buy bonds from foreign parties, you also have to deal with the currency risk. The other currency can then become more expensive, as a result of which you receive less money back in your currency.
If you care about the environment, you can choose to buy sustainable bonds. Sustainable bonds or green bonds are used to finance environmentally friendly projects. In many countries you will also receive tax benefits when you invest in green bonds.
What kind of bonds can you buy?
In addition to the standard bond, there are also special types of bonds. You must understand how the bond works before you buy it.
- Zero-coupon bond: you receive no interest on the bond. The bond is often issued at an amount lower than the redemption value.
- Convertible bond: this bond can be converted into shares under certain conditions.
- Perpetual bond: a perpetual bond has an unlimited duration. You always receive interest on the bond, but the original sum is never repaid.
- Indexed bonds: this type of bond is ideal if you fear strong inflation. The return on your bond is adjusted to the annual inflation.
The price or rate of a bond often depends strongly on the interest rate development. It is therefore smart to take the interest rate into account when buying a bond.
When market interest rates rise, bonds often decrease in value. This is because the same bond with 2% interest is less attractive when you receive 1% savings interest than when you receive no savings interest.
Other investment products also influence the price of a bond. For instance, are shares performing much better than bonds? Then the prices of bonds may fall at the expense of the prices of shares.
Another factor that can influence the price of a bond is the creditworthiness of the underlying entity. If the probability that the underlying party cannot repay the money increases, you will see the price of the bond fall.
Conclusion: how to make money with bonds?
You can make money with bonds in two ways: you can make money by profiting from the interest payments until the end of the term. In this way, you receive a fixed and reasonably secure income.
The second way you can make money with bonds is by selling the bond with a price profit. To accomplish this, you need to properly assess the market and the demand for the specific bond.
In any case, it is important to remember that there are no safe investments. Bonds have the image of being safe, but still carry the necessary risks. Therefore, investigate whether buying bonds is wise in your situation.
When I was 16, I secretly bought my first stock. Since that ‘proud moment’ I have been managing trading.info for over 10 years. It is my goal to educate people about financial freedom. After my studies business administration and psychology, I decided to put all my time in developing this website. Since I love to travel, I work from all over the world. Click here to read more about trading.info! Don’t hesitate to leave a comment under this article.