Investing for Beginners – Bonds
Investing for Beginners
Now that we have gone over the benefits of stocks and how they work, we will take a look at a safer investment method for those who prefer to invest without risking their principal (the money that you are using to invest). This investing method also allows you to see a steady increase in your brokerage account rather than a high amount of daily fluctuations that you would see if you had invested in stocks.
– Easy Difficulty
what is a bond? The easiest way to describe a bond is as an IOU where you
provide some liquidity – in the form of a principal – to a company or
institution and in return, they provide you with a promise that they will pay
you back the money in full with a fixed interest rate. When a bond is set to
expire, this is what is referred to as the maturity date – the date where the
contract ends, and you receive your principal back. The maturity date is when
the issuer, the individual who has borrowed the money from you, is expected to
repay the full amount. Bonds can be issued by almost anybody but are usually
issued by companies, municipalities – provinces, cities, states – and governments
to help raise cash quickly for necessities. As an example, there are many
municipalities that issue bonds so that they can collect money to help rebuild roads
or public buildings that are in need of renovations.
raising this cash, they can provide you, the lender, a fixed interest rate that
can be paid out monthly, quarterly, yearly or at the end of a fixed term. Usually,
the interest on bonds is paid out every year and the final year is when you
would receive both the final interest payment and your principal – the money
you lent them at the beginning of the transaction – with the redemption of your
bond. The best way to think about a bond is like a loan agreement – you provide
them with money that they can do whatever they want with and you receive in return
interest and your original principal at the end of the transaction.
can also vary drastically in their lengths as some bonds can be issued for a
short period of time (like 6 months), while others can be greater than 10 years.
The Government of Canada provides Canadian bonds that are 10 years in length
and that pay out twice a year. As an example, you have decided to purchase a
10-year Government of Canada bond for $1000. It pays twice a year and the yearly
interest rate is 1%. So the first 9 years you would receive $5 twice a year for
each year that you hold the bond. The 10th and final year, you would
receive $5 and another $5 with your original principal of $1000. So in the 10
years of owning this bond, you would have received $100 in interest and your original
$1000 of principal for a total of $1100 on your original principal of $1000.
you can see, there was no risk of losing your original principal as it was paid
back in full by the Government of Canada. But this is not always the case.
Please note that when dealing with governments or large institutions, you
should expect to receive a lower interest rate as they are unlikely to default
and not pay you back but when you are dealing with smaller companies, you will
receive a higher interest rate as there is a potential for these companies to
default. If a company defaults, you lose your principal. To help incentivize
people to invest in riskier companies, these companies tend to provide a higher
interest rate so that you are more willing to lend them money even though they
might be riskier and have a potential to default. Also, the longer the length
of the bond, the higher interest rate you will receive as your money is tied up
for a longer period and you are not able to use this money for your own
How do you Get a Return?
are actually two ways to get a return when you invest in bonds. The first way
is straightforward: you hold your bond until the maturity date – the date in which
the borrower pays you back all of your money – while collecting the interest payments
that are made monthly/quarterly/yearly. The second way to get a return on your bond
is to sell it on a secondary market to someone else for more than what you paid
How do you Pick the Right Bond?
the right bond is quite simple: there are bond rating agencies that have
created standards to analyzing a bond’s worth and providing information on what
the correct price of the bond should be. A AAA rated bond – usually a developed
and strong government that will not default – is considered the highest rated
bond and provides a low interest rate as it has almost no risk of defaulting.
If you have a C rated bond – usually a small and new company – this is considered
a low-rated bond with a high interest rate as it has the potential to default.
I mentioned, bonds tend to be a very safe option for investors and is a much
safer option than the stock market as they are less risky. But this low risk
also comes with a significantly lower return than the stock market. If you are
an individual who does not want to take on a lot of risk, you can consider
investing in bonds as they are safe and will provide a return.
me know if you agree with everything above! Would you like me to add anything
else to this post? Let me know below!
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