How Investing in Bonds Is Beneficial in 2022

While most people are aware of the basics of share trading, not many investors know about bonds. However, investing in bonds has many advantages. The biggest of them is that investment in bonds is more stable compared to other investments that could be risky.

They are an alternative avenue for those who wish to diversify their investment. But there are some things that you should know before you decide to invest in bonds.

The basics and examples of bonds

The issuer of the bond is the entity that borrows money from you. This entity then issues or gives you bonds in exchange for your money. These bonds example are a guarantee that the issuer will pay you back the money with interest at a later date. 

Usually, large corporations of governments that need money for their expenses issue bonds. Unlike stocks or shares whose prices can fluctuate rapidly, bonds provide investors with a steady, fixed income. This is why many seasoned investors usually have a few bonds in their portfolio, apart from stocks.

In fact, the market for bonds across the world is far bigger than the stock market. But for some reason, many investors do not know much about investing in bonds, though they are quite familiar with equities. You can invest in bonds directly or in a part of a bouquet of bonds. And you can invest through mutual funds or ETFs.

Terms you should know in the bond market

1. Par value

When purchasing bonds directly from a government agency or corporation, the money you pay is called its par value. It is the face value of the bond. As an investor, you receive this same par value on the maturity of the bond. 

2. Expected return or Yield

The income you expect from the bonds until they mature is known as their yield. It includes the repayment of the principal amount as well as all the coupon payments. If an investor doesn't sell the bonds till their maturity, the issuer repays the invested amount - the par value of the bonds - and the debt is cancelled.

If the bonds are sold before they mature, they are traded either at a premium or discount or even at par. It all depends on interest rates prevailing in the market at that point in time. Investors usually trade bonds before maturity.

3. Current yield

The bond's yield until maturity becomes irrelevant because it is usually traded well before maturity. So investors calculate the returns they can expect on holding the bond for a year.

This expected amount is called the bond's current yield. The current yield amount of the bond is arrived at by dividing its annual income by the current price. 

4. Fixed interest rate or Coupon

You get a percentage of its face value as a fixed interest when you purchase a bond. This is called a bond's coupon.

For instance, if you invest in a bond with a face, or par value, of Rs. 2,000 and a 10% coupon, it means you will get Rs. 200 every six months or annually till the maturity of the bond.

Trading at a premium or a discount

Once the issuer sells the bonds to investors, they can trade them with other investors if they want. This is called the secondary market. However, bonds are not traded at their face or par value in this market. They are traded either at less than their par value - at a discount or more than that - at a premium.

The following are some benefits of investing in bonds:

1. An increase in price could lead to capital appreciation 

If the economy sees an upward movement, or if the industry or issuing company sees some positive development, you can see your bond's price increasing as an investor. This is called capital appreciation. 

2. Total return

Investors usually reinvest their interest income in high-yielding bonds. Their price also changes from time to time. This reinvested income and the price changes are included in what is known as the total return performance of bonds.

In a growing economy and when there is a decline or stability in the interest rates, the total returns from high-yield bonds are lucrative.

3. Your income improves with high yield bonds 

When interest rates decline, the yield premium is very helpful. Investors are better off if they are ready to face increased risks for higher yields, at least with a small part of their assets. 

4. First to receive payments 

In case a company faces a financial disaster, those who invest in bonds usually receive their payments before the stockholders. Even those who invest in bonds that are low rated get first preference over stockholders if a company fails.

Final Thought

Bonds investment can be very beneficial if done the right way. The biggest advantage is that bonds are more stable as compared to other investment options. Invest in bonds now!