When it comes to investing, two of the most popular asset classes are stocks and bonds. Bonds—sometimes referred to as fixed income—are a common investment option, especially for retirees. While bonds are common, not many people understand exactly what a bond is and how they work. In this article, we will describe what a bond is, common types of bonds and risks associated with owning bonds.
Bonds are loans between investors and institutions—often governments or corporations. When an investor purchases a bond, the issuer of the bond generally pays interest on an ongoing basis for a specified time period. By the end of that time period, the issuer of the bond will generally pay back the original investment amount, this is often called reaching maturity. Investors looking to gain exposure to fixed income can do so by purchasing individual bonds or shares of a bond mutual fund or exchange-traded fund. A bond fund is a collective investment scheme—similar to equity mutual funds—where multiple investors pool their money together and the fund invests in many underlying fixed-income securities.
Many corporate and government bonds are traded on secondary, over-the-counter (OTC) markets, while others may be purchased directly from the issuer. Organizations will often issue bonds to raise money when they are looking to fund new projects or refinance existing debt obligations. The initial price of the bond is usually set at par or face value. The price of each bond generally fluctuates based on the maturity date, credit quality of the issuer and the interest rate (often called the coupon rate) compared to the lending environment at the time the bond is purchased.
Bonds come in many shapes and sizes. Maturity dates, bond prices and yields all fluctuate depending on the issuer and the type of bond. Common bond types include:
Investing and risks go hand and hand. While most investors associate risk with stocks, fixed income is not exempt from risk. The following is an overview of some of the risks associated with investing in bonds.
Estimating tax liability can be complicated as well, due to the differences between the different types of bonds, how they were purchased, and the specific tax treatment of the interest received. It may help to work with a tax adviser if you are concerned about the tax implications from trading bonds.
There are many factors to consider before deciding to invest in bonds. What are your investing or retirement goals? What asset allocation will help you reach those goals? How long will you need your money to last? If you determine that bonds are right for you, there are a number of ways you can increase your fixed-income exposure.
One of the most common ways investors gain fixed income exposure is by purchasing a bond fund. Bond funds are generally hold a variety of bonds from different issuers—reducing the likelihood of default risk. You also have the ability to forgo the bond market and purchase government bonds directly from the government.
Investing is complicated. Despite the complexities that come with determining an appropriate retirement strategy, the good news is you’re not alone in this goal. Fisher Investments Canada helps investors develop retirement strategies and understand their retirement needs without selling high-commission investment products. If you are trying to determine an appropriate asset allocation or would like a second opinion on yours, give us a call today or download one of our guides today!