Investment bonds are a good option to invest your savings. It is safer than stocks or options trading and comes in many different types. The world of bond investment can be quite confusing. Here you can find the basics that you absolutely need to know before investing in bonds.
Investment bonds or guaranteed equity bonds are tax efficient and can be held for long terms. This is a good way to make your inactive savings work. Your investments through a bond will be invested again in mutual funds. There are many conditions, types, fees, and opportunities to bond investments that you should know.
Table of Contents
What Is An Investment Bond?
An investment bond is like a single premium life insurance policy. It is used to put savings into investment in a manner that is tax efficient.
There are options in which you get your initial investment back, and there are options where you don’t. These are discussed in detail below.
- Investment bonds invest your money in other channels, such as mutual funds to increase value.
- You can only get your investment out if you pass away or surrender your account. Naturally you get your savings back if your investment matures.
- There are fees for different account types. Setup fees are required to set up an account. You need to pay more for an account that guarantees that you will never get less than your original investment.
- Surrender charges are applicable if you pull out your investment before maturity.
- Switching charges are applicable if you want to change funds.
10 Tips to Know Before Bond Investment
What Is Your Risk Assessment?
Your savings through investment bonds will be invested in mutual funds by your preference. You can decide if you want to invest in high-risk or low-risk funds. So it is important that you decide your financial goals and the type of risk you can afford to take.
You can invest in higher yield bonds or an investment grade bond. Your choice will most likely be dependent on your risk-return assessment and the credit opportunities. How much risk you are willing to take will determine your investment strategy.
You need to know the negative effects from failed investments, the cost of such failed investments and the possible return of the risky investments.
Is the Bond Safe to Invest in?
The risks associated with bond investment can reduce the value of your savings over time. Inflation risk, liquidity risk, interest rate risk, and credit risk are some of them.
Credit rating and management companies can help you with risk assessment of an investment. You can also use online tools that are available to assess your investment portfolio yourself.
- Credit ratings of bonds evaluate the issuer on the ability to repay their dues. AAA rating means the ability is reliable, while D means they are not reliable.
- Rising interest rates mean a fall in prices of older bonds. Alternatively, falling interest rates will increase the price of bonds with high interest rates.
- High inflation means lower purchase power for bond coupons. It increases interest rates and reduces bond prices.
- Bonds that are part of larger issue sizes have lower liquidity risks. Government-issued bonds have larger issue sizes than corporate ones.
Is the Bond Compatible with Your Target Returns?
You may have specific goals such as buying a dream house that you want to fulfill with the returns you get from your bond investments. You should select the bonds according to them.
Bonds have different maturity rates. Savings bonds usually have a longer maturity time. Investment grade bonds have lower risks and low returns. High-risk bonds have high returns but low credit ratings.
You should choose the type of bond to invest in according to your needs. Remember that you can’t pull out a bond before it matures without paying a fee. So keep in mind the maturity rates.
Corporate bonds have the highest yield and also high risks. Government bonds have very low yields, but they also have very low risks.
Hold the Bond Till It Matures
You should always allow your bonds to mature. A bond becomes mature when its principal sum becomes due. After the maturity period, your principal amount will be returned to you, and you will stop receiving interests on your investment. Maturity concludes the bond investment.
Fixed income security bonds are ‘callable.’ The issuer of a ‘callable’ bond can decide to pay back the principal sum at any time. The fixed income security bonds are issued by the US Treasury. There are three types of maturity terms.
- Short term is a period of 1-3 years
- Medium term is a period of 10 or more years.
- Long term is usually for over 30 years.
Invest in the bonds that would suit your investment strategy and let it mature fully. This way you’ll get the most benefit out of your investment, and you can also avoid paying the surrender fee.
Read the Prospectuses
Never ditch reading the bond prospectus. Bonds are all different and have different credit ratings, maturity rates, conditions, and benefits. You should always read and compare the prospectuses carefully to know the type of bond you’re investing in.
Companies need to file their prospectuses with the Securities and Exchange Commission. These contain the risks and every other detail about the investment.
You will get to know the principals, management, financial background, number of shares, and many other important information through the prospectuses. You can make better decisions about investing by knowing this information.
Consult a Broker House
Consulting a good broker house is a good option to ensure safe and better investment in the bonds market. The broker house can also diversify your accounts. They can invest in mutual funds, bonds, ETFs, and purchase stocks. They also take care of your securities and advise you on new investments.
It is important to select a reliable broker house to open your account with. You can look into the company’s history and background. Reputable companies can usually be trusted. You should also look into the management of the company. If the people at the top have a good reputation and good record, then the company can be considered reliable.
Look out for companies with people who have a history of financial fraud in management. They have a tendency to repeat previous offenses. A good credit rating and client review can also be a sign of a reliable broker house.
Try to Reinvest Your Coupons
Reinvestment of your coupons will end up yielding more than your original investment. The coupons that are invested will get interest on them as well. This will generate a good amount of compound interest over time.
When investing coupons, you should keep in mind that there will be additional fees charged. Your risk assessment of the bond account should also be considered. If the bond is too risky, then reinvestment should be avoided.
You should create a separate coupon account to draw your coupons and reinvest them. The highest yields are gained through compound interest by reinvesting coupons. However, if there are better bond options to invest in, then you should calculate and invest your coupons in them.
Try to Maintain Your Investment Strategies
After you decide on an investment strategy, try to maintain it without diverging. Consult with your broker to decide what type of investment will be best for you. Don’t get nervous about investing in riskier bonds with higher yields. Always choose companies with a good credit rating.
Don’t sell off a bond if you start getting low interest rates. Waiting for maturity is always a good idea.
Know the Interest Rates
There are two types of interest that are offered through bonds. These are floating and fixed interest rates. A fixed interest rate remains fixed during every coupon payment. Floating interest fluctuates depending on the issuer.
In the US, three thresholds are used to determine the rate of a fluctuating interest policy. These are the US Treasury rate, LIBOR rate, and the federal funds rate. The bonds with floating rates are usually short term bonds with maturity rates of 2-5 years. You should read the prospectuses carefully to understand the fluctuating rate of a bond.
What About Defaults?
Bonds have many risks including those of defaults. Since the issuer fully discloses their risk assessment in prospectuses, you may not get your investment back unless there are conditions letting you do so.
Credit rates are a good way to know if there’s enough security to get your investment back. However, you should constantly keep an eye out on the activity of the management. Investment bonds in some states may be covered by the FSCS. In this case, you may get your money back in case of a default.
You should also check if the bond you’re buying is older. In some cases, issuers prefer to pay back older bonds first after a default. You should check company policies to know how a company pays back its debt after a default.
Conclusion
Bond investment is tricky and requires careful planning. Make sure you have enough time to monitor the market and have a good broker house. You should always be open to learning more about bond investment. Hopefully this article helps!