Bonds provide stability, safety & income
 Bonds
serve three purposes in your portfolio: to stabilize your
overall return, to provide an element of safety and to generate
steady income.
Like a GIC, a bond is a debt instrument. When you invest
in a GIC you’re lending your money to a bank, and in
return they pay you interest. When you invest in a bond, you’re
lending your money to a corporation or to a government –
the issuer – for which they also pay you interest.
Like a GIC, the amount of the loan – the face value
of the bond – is guaranteed by the issuer to be repaid
when the bond matures. However, with a GIC, the value is guaranteed
by a bank and insured by the CDIC (Canadian Deposit Insurance
Corporation).
With a bond the guarantee is only as good as the issuer.
If the issuer runs into financial difficulty, they may default
when the bond matures. Which is one reason why bonds pay higher
interest than GICs. Generally, the rate of interest you’ll
earn on a bond is related to the credit rating of the company.
The expression “junk bond” refers to a bond issued
by a corporation, which does not have a good credit rating.
A junk bond generally pays a much higher rate of interest
because the possibility of default is so much higher, which
is why they must be considered a speculative investment.
Another difference between a GIC and a bond is the maturity
period – bonds generally range from 5 years to 30 years.
Plus bonds may be sold in the bond market at anytime before
they mature. In addition, because of fluctuations in interest
rates, the price of the bond in the market may be higher or
lower than the face value.
That means you can make money with a bond in two ways: you
can earn interest income plus you can sell it for more than
you paid, giving you a capital gain.
The price of a bond, as opposed to its face value, is largely
determined by the level of current interest rates and the
credit rating of the issuer. As rates go up, the price of
bonds on the market tend to go down.
The interest rate paid by a bond is determined by the level
of current interest rates, the term of the bond (generally
the longer the term, the higher the rate) and the issuers
credit rating.
Canada Savings Bonds have for many years been one of the
most popular investments in Canada. And with good reason.
They have several unique features that make them attractive
to many investors:
-
they can be purchased for as little as $100 (most other
bonds are a minimum of $1,000)
-
they can be redeemed at face value at any time
-
you can choose simple interest – you can receive
regular annual payments – or compound interest –
interest is reinvested and paid in full on redemption
Another type of bond that has become popular in recent years
is the provincial savings bond. They have similar features
to Canada Savings Bonds.
Bond funds can be a good way for the average investor to
invest in bonds
If you want to invest in bonds, you should hold a diversified
mix of bonds. However, since most bonds are priced at $1,000
or more, it takes quite a bit of capital plus time and effort
to build a properly diversified portfolio of bonds. A solution
is to invest in a bond mutual fund.
For a reasonably small investment, you can participate in
a diversified portfolio of professionally managed bonds. The
fund manager can purchase a number of different bonds, and
in denominations that offer more favourable interest rates.
Short-term bond funds can be ideal for holding money that
you’re eventually going to invest. Suppose you receive
an inheritance or a lump-sum distribution from a retirement
plan. Although most investors would likely put those funds
in a money market fund, you could put it in a short-term bond
fund until you decide what you’re going to do with it.
And depending on the timing, you’ll likely earn more
than in a money market fund.
If you’d like to know more about the role bonds should
play in your portfolio, click
here to find the RBC financial planning professional closest
to you.
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