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IF IT has been your dream to put money away for your children's tertiary education, to buy a new home or to build up your retirement savings, investing in bonds might help you achieve your objectives.
Bonds can simply be described as an "IOU" in which an investor agrees to loan money to a company or government in exchange for a certain interest rate, paid over a fixed length of time. The longer the time period for the loan, the higher the interest rate received by the investor.
Should a business want to expand, one of its options is to borrow money from individual investors, pension funds or mutual funds. The company then issues bonds at various interest rates and sells them to the public. Investors purchase these bonds with the understanding that the particular company will pay back their original amount plus any interest by a set date.
Governments, companies, banks, public utilities and other large entities normally issue bonds. It is important to note that bonds are not risk free. Particularly in the case of corporate bonds, it's always possible for the borrower to default on the debt payments. The risk of a default is generally measured by the borrower's credit rating, with "AAA" as the highest possible rating. AAA-rated bonds are therefore the safest you can buy.
Why invest in bonds?
Bonds are generally considered to be safer investments than stocks (equities) or listed property. This is because companies are required to repay their bondholders first, before their shareholders or any other debtors. Also, they offer more stable returns than those available from the stock market, as interest is paid regularly, so they're a good option for risk-averse investors.
Bonds provide a predictable income stream as they generally pay interest twice a year. People normally invest in bonds for that expected regular interest income and also to preserve their capital investment. Because of these benefits, bonds can play a particularly important role in your retirement planning.
How do you invest in bonds?
You can buy bonds directly from the Johannesburg Securities Exchange (JSE) or in turn access them via bond unit trusts. Buying a bond on the JSE involves the services of a broker, either directly or online. This is probably the cheapest way to access the market, although the minimum amount purchased can be fairly high. Another drawback is the research and time involved in determining which bond(s) to buy. As it's never a good idea to put all your eggs in one basket by buying only one bond from one issuer, you'd need to spread your investment across a few different issuers.
Meanwhile, a bond unit trust pools together the money of many individuals and invests in the bonds of a range of different issuers. The investor buys units, which represent a portion of the combined value of all the different companies' bonds. Unit trusts can be bought through your financial adviser or by going direct to an investment group like Old Mutual Unit Trusts.
The benefits of unit trusts over listed bonds are diversification and affordability. Because a bond unit trust is diversified across a number of types and companies, there is less risk than investing in only one bond. Another advantage is that you can invest as little as R500 a month.
The disadvantage of unit trusts is that they generally cost more than investing directly via the JSE. This is because you are paying a professional fund manager to choose the best bond investments and manage them on your behalf.
So, as part of a balanced investment portfolio, bonds can help to reduce overall risk through diversification and also play a role in providing a steady income over time.
It's worthwhile to get an investment adviser to show you how best to make bonds part of your portfolio.
l The writer is head of distribution, Old Mutual Investment Group (SA)