By Amy Xie Patrick, Portfolio Manager with 12 years of global investment experience. Amy graduated with honours in Economics from the University of Cambridge 🎓.
When bond (a.k.a fixed income) experts try to explain bonds, it’s easy to get stuck in the mechanics with a lot of financial jargon ⚙. So when people at dinner parties ask what we do, eyes tend to glaze over pretty quickly 👀.
In fact, I don’t think my parents really know what I do 🤔.
So I’m going to take a simpler approach, taking a leaf out of Dr Laura Ryan’s Carrot from a couple of weeks ago when she explained how to lower your risk when investing📖.
So … what are these bond things?
Bonds are like term deposits. When we deposit our money in a bank, we’re lending our money to that bank, who will lend it on to someone else. Committing to a 3-year term deposit at a bank is very similar to buying a 3-year bond. In both cases you agree how much you’ll be paid (the return/interest rate) on your money, and the date when you will be repaid.
You can buy bonds issued by governments or by companies. Buying a bond means you’re basically lending money to the bond issuer.
In countries like Australia, government bonds are especially safe, because you know you’ll get your money back.
In good company
Investing in bonds issued by companies (a.k.a corporate bonds) is riskier, because there’s a chance the borrower won’t be able to repay you. You should get a higher return on your investment to compensate you for this risk.
Why should bonds matter to me?
From Dr Ryan’s Carrot recently, we know that diversification (not putting your carrots in one basket🗑) is really important for investing.
Bonds are good because they can provide diversification.
Why do bonds help?
When investors get jittery, they start selling their riskier investments such as shares, getting their money out in case things go pear-shaped 🍐. That means shares fall in value 🍁. People then buy bonds because they’re safer, which in turns pushes up bond prices. Shaken, but not stirred. 🍸
When shares go down, bonds often go up.
This gives you that precious diversification. Shares and bonds are like bread and butter: they go well together! 🍞
NB: It’s all about you
Remember to match the type of investments with when you will need the money. If you’re saving for the long term, then shares and bonds together can work really well 👵🏽. If you’re saving for a holiday in six months, it’s probably better to save the bother and stick with that trusty term deposit 🏖.
Also, if you’re young, you have a longer timeframe for investment over your lifetime. That means you can probably take more risk than someone who’s about to retire. All of this depends on your situation and your preferences.
OK. I’ve bonded with the idea of bonds. How do I buy one?
Don’t buy a bond on its own. Instead, buy a portfolio of many bonds, so you don’t have all your carrots in one basket 🗑🍳🍳.
It’s not super easy to access diversified bond funds in Australia.
However, you can buy a number of pre-made baskets (portfolios) of bonds through a managed fund, or an exchange-traded fund (ETF).
Managed bond funds can be accessed directly through fund management firms, or through a financial advisor.
ETFs such as those from Vanguard or iShares, are available on the Australian stock exchange, which makes them easier to buy in small amounts. You can purchase them through online brokers like CMC markets or CommSec.
Finally, as with any investment, always check the fees!💰
Thanks Amy, we think we can explain what you do to your parents for you now! 😜 Questions for Amy (or anyone else)? Send us a note at firstname.lastname@example.org.
Next week we’ll be back with a piece on how to invest in pre-made baskets (portfolios), which makes everything a bit easier. Our guest next week can do most of the heavy lifting for you!