How do you invest in the bond market? A beginner’s guide

Protect your portfolio against volatility by investing in government or corporate bonds

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Government and corporate bonds are considered one of the safest investments in the market. When you invest in the bond market, you’re essentially lending money to a business or to the government at a fixed interest rate.

While you can’t usually expect the same high returns by investing in bonds as you get from shares, you can expect a lot more security. For this reason, the bond market does especially well as the share market becomes more volatile and interest rates fall.

If you’re ready to start investing in bonds, there are several avenues that you can take, including wholesale investing via a company or broker, and through investment products, such as bond-themed exchange traded funds (ETFs).

What is a bond?

Simply put, a bond is a loan that you make to either the New Zealand government or a company at a fixed interest rate for a pre-determined period of time. In return, you receive interest payments on your investment on a regular basis, with the principal amount paid back to you at the end of the term.

Where shares normally return value as the stock markets rise, bonds act as a counterweight to a portfolio because they tend to do better when the economy is under-performing. Before making a choice, you should carefully compare your options as some will pose more risk than others.

What are the different types of bonds?

In New Zealand you have a few different options when investing in bonds. Each choice has its own risk and return potential, making it important that you compare your options carefully before deciding on any one product:

  • New Zealand Government Kiwi Bonds. Kiwi Bonds are issued by the New Zealand government in six month, one-year, two-year and four-year maturities. These can be bought directly over the counter (OTC) through certain registered banks, investment brokers, via the NZX Debt Exchange (NZDX) through a broker or an online trading account. The interest rate is fixed, with payments made to you quarterly in arrears.
  • Corporate bonds. This type of bond is usually a part of a public offer, where a company will issue a prospectus and investors are able to make a direct investment. This is different from buying shares, where you are a part owner and your investment is affected by the cashflow of the business. With corporate bonds, you make a loan to the company and your return is limited to the agreed upon interest payments and the return of your principal investment.

What is the NZX Debt Exchange?

The NZX Debt Exchange (NZDX) is a secondary market where bonds are listed, and where investors can buy or sell bonds. You can sell a bond before its maturity date if you need the cash, but with brokerage fees around $35 a trade, it’s best to stick to new issues and hold them to maturity where possible.

How are bonds valued?

A bond’s capital value can increase or even decrease before the maturity date based on current interest rates. The amount of interest accrued since the last coupon payment will also have an effect on the value of a bond. If interest rates drop, you will see an increase in the value of your bonds, whereas when they rise the value of your bonds will drop as a result. These fluctuations are only relevant if you have invested in floating rate bonds as opposed to fixed rate bonds.

How do I start investing in bonds?

You can invest in government or corporate bonds either over the counter (OTC) or via the NZX Debt Exchange (NZDX). In both cases you’ll be required to have a broker or fund manager. Investing in government or corporate bonds usually requires a minimal investment (typically $1,000 for government bonds and $5,000 for corporate bonds).

An easy and relatively cheap way to access the bond market is through bond exchange traded funds (ETFs). An exchange traded fund is a bundle of securities that has been listed on a stock exchange, such as the Smartshares NZ Bond ETF. Bond ETFs typically track a corporate or government bond index to imitate its returns.

These products can be bought and sold on a stock exchange through an online trading platform or a full service broker. If you’re considering investing in bonds through an online broker, be aware that there may be additional risks involved – especially if you don’t understand the product.

Invest in bonds via CFDs

An alternative to buying bonds is to speculate on their price movements through CFD investing in the futures market. CFD investors seek to profit from bond price movements – whether up or down. That means that even if bond values are falling, CFD investors can still make a profit. However, because CFDs can be highly risky and are complex derivative products, CFDs are better suited to advanced traders. You can read more about CFDs in our comprehensive guide.

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Pros and cons of government bonds vs savings accounts

Are you thinking of moving your funds from a savings account into government bonds? If so, there are several considerations you need to be aware of, such as the bond’s maturity date and minimal investment requirement. Below are some pros and cons of investing in bonds versus keeping funds in a savings account.

BondsSavings accounts
Pros
  • NZ Government Kiwi Bonds are considered safe due to New Zealand’s credit rating
  • Deemed low risk
  • Could receive a higher return than savings
  • Protected by the Government Guarantee
  • Deemed low risk
  • Able to earn compound interest
  • At-call access to funds
Cons
  • Required to wait until the maturity date
  • Interest payments less frequent
  • Needs a minimum investment amount of $1000
  • Could receive a lower return than bonds

Remember, before you get started, it pays to asses your financial situation to determine whether investing in government bonds is right for you.

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Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.

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