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.
What is a bond?
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.
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.
You can only buy or sell bonds through a sharebroker, or an online dealing service.
Learn about different types of bonds.
Understand the risks
- 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.
Things to look out for
1. Find out if the pricing or any other key features of the bond have changed
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. A financial adviser or broker will be able to provide more current information.
2. Credit ratings should only be used as 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.
3. All bonds have different risks
There is a section in the PDS called ‘specific risks’. This gives you an idea of what can significantly increase the risk of you losing money on your investment. These risks will be different for each bond.
If you buy bonds without a maturity date (perpetual bonds), you could be exposing yourself to risks for a longer time. Check the information in the ‘key terms of the offer’ and ‘key features’ sections of the PDS.
How to reduce risk
- Bond laddering – 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.
- Diversification – 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.
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EXAMPLE: 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.
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Selling your bonds
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.
