When you invest in bonds, you are effectively lending money to a
government or company at an agreed interest rate for a certain
amount of time. In return, the borrower promises to pay you
interest at regular intervals and repay your loan at the end of the
term. Bonds should be considered as part of a diversified
However, not all bonds are the same, ranging from very safe to
very risky. Here are some things you should look out for before you
invest. If you're still unsure, seek financial advice.
How bonds work
Bonds have a face value, which is the amount you will get back
at maturity and a coupon amount, which is
the interest paid each year. This payment may be divided into
half-yearly or quarterly amounts.
This is simple if you buy a bond at the start of the term and
hold it to maturity. Things are more complicated if you only hold a
bond for part of the term.
Bonds that you can trade on a secondary market such as the Australian Securities Exchange (ASX) are
known as 'listed' or 'exchange-traded' bonds. Listed or
exchange-traded bonds give you the flexibility to sell the
investment if your circumstances change.
How interest rates are calculated
Bonds can pay interest at a fixed or floating rate.
Fixed rate bonds
The interest on a fixed rate bond is set when the bonds are
issued and is shown as a percentage of the face value of the bond.
The interest rate stays the same for the life of the bond.
Floating rate bonds
The interest rate for floating rate bonds varies in line with
movements in a benchmark interest rate. This means the coupon
payment will vary each time, sometimes quite substantially. You
could get higher returns if the benchmark interest goes up, but you
could also get lower returns if the benchmark interest rate goes
Check the bond's prospectus for information on
how and when the floating rate will be calculated for coupon
In an investment portfolio, bonds may serve a different function
to conservative investments such as savings and deposit accounts.
The market value of bonds can go up and down depending on what's
happening in the economy and with interest rates.
Certain bonds tend to perform well when other markets are
struggling. For this reason, they are often seen as a defensive
investment, as well as a source of regular income.
Over the last 25 years some high quality fixed rate bonds have
provided comparable, and in some cases, better than average
returns, compared to Australian and international shares and listed
property. They have also been less volatile than shares,
with fewer years of negative performance.
Case study: Jason diversifies his investments
has investments in shares and property. As he's nearing retirement,
he decides to visit a financial adviser for advice about including
less volatile, interest paying investments in his portfolio. After
considering his adviser's recommendations and doing his own
research, Jason decides to invest some of his money in bonds
through a fixed income managed fund. The recommended fund invests
in highly-rated government and corporate bonds, and has a strong
track record. Jason understands that the past performance of the
fund is no guarantee of future performance. However, because of his
age and risk profile he decides that it is a good time to include
more defensive assets and better diversify his investment mix.
How safe is a bond?
Bonds range from very safe (for example, Australian Government
bonds) through to very risky (unlikely to repay your money). Its
very important to know what you're investing in, as not all bonds
or fixed interest investments are the same.
In general, bonds are less volatile than other investments such
as shares. However, losses are still likely to happen in some
years, as individual companies and even governments, sometimes
default on their obligations to bond holders.
Most bonds have a credit rating, but most ratings agencies only
make this information available to wholesale clients and advisers.
It is really difficult for a retail investor to assess how risky a
Ask a licensed financial adviser to help you work out
the quality of the bond you are considering
How bonds are valued
The capital value of a bond can rise or fall depending on the
current interest rate and the amount of interest accrued since the
last coupon payment.
For example, if a bond has a face value of $100 but you bought
it 11 months after the last annual interest payment was made, you
would have to pay the seller more than $100 to take into account
the interest accrued.
A bond's capital value can increase or decrease before maturity
based on current interest rates.
Let's say you bought a 10-year bond yesterday with an interest
rate of 5% per year. If market interest rates halved overnight to
2.5% per year, then the income from your bond would be twice as
valuable. This would increase the price of the bond.
If interest rates had doubled to 10%, the income from the bond
would be only half as valuable. This would decrease the price of
How to invest in
There are a number of ways you can invest in bonds and fixed
Australian Government bonds
The Commonwealth of Australia issues bonds called Commonwealth
Government Securities (CGS). For more information, see Australian Government
State governments and territories may also issue bonds.
Information can be found on each state and territory's treasury
Most retail investors buy corporate bonds through a public
offer, where a company issues a prospectus and investors apply to
the company directly. You can also buy and sell some corporate
bonds on the ASX.
See corporate bonds and ASIC's guide
to investing in corporate bonds for more information.
Your super fund
Most super funds allow members to choose a mix of defensive
(cash and fixed interest) and growth (property and shares)
investments. To find out more see super investment options.
An investment professional can invest your money in a range of
bonds through a managed fund or index fund. For more information
see choosing a managed fund.
Hybrid securities and subordinated notes
These investments have higher risks than most types of corporate
bonds. For more information see hybrid securities and
Bonds can provide a regular, dependable source
of income but be aware of their risks, know what you're investing
in and do your research. If you are unsure, ask for professional financial
advice before investing.
Last updated: 18 Dec 2015