Investing in Bonds – also known as fixed income instruments - is an investment approach focused on preserving capital and generating regular income. It typically includes investments like government and corporate bonds, CDs and money market funds that are used by governments or companies to raise money by borrowing from investors.
Bonds are typically issued to raise funds for specific projects or general working capital requirements of a company. In return, the bond issuer promises to pay back the investment, with interest, over a certain period.
Low risk investment
Bonds can play a vital role in any investment portfolio. Bonds yield income are often considered less risky than stocks and can help diversify your portfolio.
Bonds are a great investment option for people requiring fixed monthly or annual earnings. You can lend money to private or public institutions, upon which you will get fixed interest, as well as the receipt of the principal amount at the end of the tenure. They diversify and enhance your investment portfolio and hedge the risks of your portfolio in a volatile market. Thus, they are a relatively less volatile investment option than equities and enable you to gain fixed returns.
Even though investment in bonds is less volatile, there is a risk of delay or non-repayment of interest or principal and hence it is important that investors not only chase higher interest rates, but also under the risk of the instrument they are picking to invest in.
Here are a few easy tips on choosing bonds to help you optimally use this financial instrument.
1. Verify the credibility of the broker
It’s better for investors newly dabbling in bonds to choose a broker that has been in the business for a long time. That way, you can trust them with your money. Additionally, don’t forget to check their fees and commissions to get a complete picture of all the costs associated with investing in bonds. Approach your investment advisor or known investment platforms to make safer decisions.
2. Choose a mutual fund or ETF
You can save time and energy by investing in bonds through debt mutual funds or exchange-traded funds. In doing so, you don’t have to select the bonds you invest in personally. Instead, the mutual fund manager or ETF strategy does it for you, typically based on the kind and duration of the bond.
3. Check the bond rating
Bonds with a rating of A or lower reflect a higher chance of default and loss of capital and while bonds below BBB rating are considered low-quality or junk. AAA is the highest rating for a corporate bond, so check how close your bond’s rating is to this benchmark. If you prefer the safest instruments then you can even look at sovereign rated government securities which are backed by RBI on behalf of the Government of India / State Governments.
4. Assess your risk tolerance
For those with a substantial risk appetite, low-quality bonds might be an option since they offer higher yields to compensate for the increased risk. On the other hand, investors with a lower risk tolerance can stick to high-rated bonds for their investment.
5. Focus on your investment horizon and bond’s duration
Bonds are highly vulnerable to inflation risks and interest rate changes, where a higher interest rate decreases their value. That is why it is advisable to limit your bonds’ duration or hedge the interest rate risks with mitigating strategies in-built into the bond. You must focus on your investment goals to ensure that your bonds yield the returns you expect them to. With these tips, we hope you can make a wise choice while investing in bonds and earn maximum returns to build your wealth.
Vivek Goel, Co-founder and Joint Managing Director, Tailwind Financial Services, a new edge wealth management platform.