Key things to know before you invest
When you buy a bond, you’re lending money to a bond issuer - usually a government, council or company - for a set period of time (the term). The term is fixed by the issuer and can range between one and 30 years. They’re often known as ‘fixed interest’ investments.
The bond’s interest rate, also known as a coupon, is fixed at the time of issue. Interest is paid through the bond’s lifespan. At the maturity date, you’ll also be paid the face value of the bond.
You can only buy or sell bonds through a sharebroker, or an online dealing service.
Find out if the pricing or any other key features of the bond have changed – product disclosure statements (PDSs) don’t need to be kept up-to-date. A sharebroker will be able to help you with this.
Credit ratings should only be used as an initial assessment of risk – Credit ratings help you understand how likely it is you’ll get your money back at maturity, and that interest will be paid on time. Ratings are issued by independent agencies such as Standard & Poor’s, Moody’s and Fitch. However, you need to be aware that these agencies have different credit rating systems, and they’re only one factor you need to take into account.
When comparing bonds, take care as the credit rating doesn’t always apply to the issuer of the bond. It can apply to the bond itself or to the issuer’s holding company. There may also be no credit rating.
All bonds have different risks – There is a section in the PDS called ‘specific risks’. This gives you an idea of what can significantly increase the risk of you losing money on your investment. These risks will be different for each bond.
If you buy bonds without a maturity date (perpetual bonds), you could be exposing yourself to risks for a longer time.
Check the information in the ‘key terms of the offer’ and ‘key features’ sections of the PDS.
You can usually sell listed bonds by trading on bond markets, such as the NZX Debt Market.
If a bond’s listed, you’ll see its value and the number of trades. The more trades there are, the easier it’s likely to be to sell your bonds. A market with few potential buyers means you could struggle to sell your bonds at a reasonable price.
If a bond’s not listed, you’ll need to take extra care to determine whether the price being charged is appropriate. Check the financial information in the PDS and on the bond register entry and seek professional advice if necessary.
Bond laddering – Choosing bonds with different maturity dates gives you access to cash at different times. It also reduces the chance that all your bonds mature at a time when interest rates may be high and yields are low, which means you’ll make less money on your investment.
Diversification – Choosing different types of bonds increases the chance that some will perform well when others don’t. Consider bonds that fit your financial goals and tolerance for risk. This could include a mix of government and corporate bonds, bonds that mature at different times, or more complex bonds.
How you can make or lose money when selling your bond
Your biggest risk when selling bonds is what has happened to interest rates since you bought them.
If your bond’s paying a higher interest rate than current rates, it will be more attractive and you may receive more from the buyer than what you paid. If it’s lower, you may receive less.
The maturity date also matters as this determines how much longer a buyer will receive interest payments.
For investors, the overall yield (or return) is important. This takes into account the interest rate, maturity date, and the price of a bond. Working out the price and yield of bonds can be complex and bond traders use sophisticated computer programmes to do this.
Here is a simplified example of how you will be exposed to bond risks:
If you buy a $1,000 bond with a 10% coupon rate, you are agreeing to receive $100 in interest, or a 10% yield.
Should interest rates rise, other bonds will come onto the market with higher coupon rates. So your bond may be competing with a $1,000 bond with a 12% coupon rate, which is a 12% yield.
To get a higher yield from your bond, buyers will offer less for it. If they buy at $800, for example, they will still get your $100 interest, which is a 12.5% yield.
For advice about your personal situation, we recommend you speak to a financial adviser.