Bonds generally offer more stable returns and lower risks than investments such as property or shares. But some bonds are riskier than others. Make sure you understand these risks.
When you buy a bond, you’re lending money to a bond issuer - usually a government, council or company - for a set period of time (the term). The term is fixed by the issuer and can range between one and 30 years. They’re often known as ‘fixed interest’ investments. Learn about different types of bonds.
Bonds are also known as fixed-interest investments. They are an income asset as you’ll receive income if you hold the bond until maturity.
You’ll get interest plus the original value of your bond
The bond’s interest rate, also known as a coupon, is fixed at the time of issue. Interest is paid over the bond’s lifespan. At the maturity date, you’ll also be paid the face value of the bond.
Sites like interest.co.nz publish bond rates
Use comparison websites to see how your bond is returning relative to other similar bonds.
The yield tells you the performance of a bond.
You can measure the performance of a bond by working out the amount of return you’ll get compared to what you paid. This measure is known as the yield and is calculated by dividing the interest received by the last traded price of the bond. Note that bonds aren’t always traded at face value.
Websites like www.interest.co.nz list current New Zealand bond yields. Your adviser or broker should have information about how to review the performance of bonds from other countries.
If you buy a $1,000 bond with a 10% coupon rate, you are agreeing to receive $100 in interest or a 10% yield.
If interest rates rise, other bonds will come onto the market with higher coupon rates. So your bond may be competing with a $1,000 bond with a 12% coupon rate, which is a 12% yield.
To get a higher yield from your bond, buyers will offer less for it. If they buy at $800, for example, they will still get your $100 interest, which is a 12.5% yield.
Understanding the risks
Companies issuing bonds must follow disclosure rules. They must have a licensed supervisor who checks they continue to meet their obligations. While some bonds are low risk (eg NZ Government Bonds), others have features that make them a much higher risk.
Pricing and other key features may differ from what is disclosed
If the bond you’re thinking about buying is not new to the market, key information contained in the product disclosure statement (PDS) may have changed since it was first issued.
Credit ratings only an initial assessment of risk
Credit ratings help you understand how likely it is you’ll get your money back at maturity, and that interest will be paid on time. Ratings are issued by independent agencies such as Standard & Poor’s, Moody’s and Fitch.
Be aware that these agencies have different credit rating systems, and they’re only one factor you need to consider. Also, be aware that the credit rating doesn’t always apply to the bond issuer. It can apply to the bond itself or to the issuer’s holding company – or there may be no credit rating. See our credit ratings page.
Some bonds have features that make them higher risk
Perpetual bonds don’t have a maturity date. You could be exposing yourself to risks for a longer time.
Rate reset bonds do have a maturity date, but their interest rate can change over the course of the bond.
Capital notes are a type of bond, often issued by well-known banks. They contain features that enable the provider to change the structure of the investment – for example into shares. Read more about capital notes.
The fees charged will vary depending on the type of service you choose.
Fees charged will depend on how the bond is issued
Some bonds are issued direct to retail investors. In that case there will be no fee to pay to purchase the bond.
After the initial issue, bonds are bought and sold through a broker, or an online dealing service. The fees charged will vary depending on the type of service you choose. You will pay a minimum brokerage fee for each order placed and may have to pay a percentage fee for any amount over the minimum.
What to do before you invest
New bond offers can be seen on Smart Investor. You can only buy bonds through a broker or online dealing service.
Read the section called ‘specific risks’ in the bond’s Product Disclosure Statement (PDS). This section explains the factors that can increase the risk of investors losing money. These risks will be different for each bond.
Make sure you also check the information in the ‘key terms of the offer’ and ‘key features’ sections of the PDS.
Bonds without a maturity date (perpetual bonds) expose investors to risks for a longer time.
Do extra research if the bond is not new to the market
Key information contained in the product disclosure statement (PDS) may have changed since it was first issued. A financial adviser or broker will be able to provide more current information.
Check you can sell your bond easily if you need to
You can usually sell listed bonds by trading on bond markets, such as the NZX Debt Market.
If a bond’s listed, you’ll see its value and the number of trades. The more trades there are, the easier it’s likely to be to sell your bonds. A market with few potential buyers means you could struggle to sell your bonds at a reasonable price.
If a bond’s not listed, you’ll need to take extra care to determine whether the price being charged is appropriate. Check the financial information in the PDS and on the bond register entry and seek professional advice if necessary.
Choosing different types of bonds increases the chance that some will perform well when others don’t. Consider bonds that fit your financial goals and appetite for risk. This could include a mix of government and corporate bonds, bonds that mature at different times, or more complex bonds.
Bond laddering, or choosing bonds with different maturity dates gives you access to cash at different times. It also reduces the chance that all your bonds mature at a time when interest rates may be high and yields are low - which reduces the money you’ll make on your investment.
Managing your investment
Bond issuers are required to produce financial statements each year.