I’m willing to bet that if you ask everyone you know where they deposit their hard-earned money, they’ll say banks 90% of the time.
We’ve been taught to save money in our plasticky little piggy banks since we were five years old, then move on to big-boy (and big-girl) banks as soon as we can. After all, where else should we put our money?
Right?
Banks, on the other hand, are excellent for this function. They’re a safe place to stow our money, whether it’s for emergency finances, future expenses, or just a general stash to dump our extra cash.
However, just like our favorite piggy banks, genuine banks don’t help us increase our money very well.
We’ll go over everything you need to know about this underutilized investment tool in this article.
Things like how they function, how much money you can make from them, and how to get started investing in them—and more. By the end of this article, you’ll have added another tool to your financial toolkit, allowing you to build assets faster and achieve financial independence.
What exactly are bonds?
It’s essentially a reverse utang (loan). How? Instead of the traditional lender-borrower relationship, in which the borrower contacts the lender and asks for money, a bond requires the borrower (bond issuer) to produce a contract (bond) that lays out the terms of repayment to the lender (bondholder).
Imagine a bond as a contract that specifies something like this, “In 10 years, our company will pay the owner of this bond Php50,000 (face amount of the bond) (face value of the bond). In addition, we’ll pay a yearly interest rate of 5%.
The borrower, not the lender, is the one who sets the terms in this scenario. It also gives the borrower additional flexibility because they can create bonds with several bondholders rather than just one.
It’s a fantastic approach to raise a large sum of money without being reliant on a single lender. This is why the government and large firms are extensively leveraging bonds.
The clincher: Bonds can also be traded! You can truly sell your bonds in the stock market if you’re a bondholder. This option makes the bond more flexible as a financial instrument if you decide not to wait for the bond’s maturity for any reason (or strategy).
Types of Bonds
Bonds are the most prevalent type of fixed income security, which are defined as financial instruments that pay a predetermined amount of interest in the form of coupon payments and return the principle to the investor (in the case of bonds, the bondholder) at maturity.
Maturity-based bonds
Bonds are classified according to how long they will take to mature.
- T-bills (Treasury Bills) are short-term bonds that maturity in less than a year (short term). The most common tenors (length of maturity) for T-bills are 91 days, 181 days, and 364 days.
Pros:
In less than a year, it matures (shorter investment time frame)
Sold at a discount from their face value but the investor will obtain the entire amount upon maturity (functions like a zero-coupon bond) (works like a zero-coupon bond)
Cons:
Does not pay revenue or interest on coupons.
- T-bonds (Treasury Bonds) — Bonds with a tenor of more than one year. T-bonds come in a variety of maturity lengths, including 2-year, 5-year, 7-year, 10-year, 20-year, and 30-year bonds.
Pros:
For the duration of the bond, the investor receives coupon interest (fixed income) at regular intervals.
Cons:
Because of the longer time it takes to grow, it poses a larger risk.
Issuer-based bonds
These are bonds that are divided into categories based on who issued them:
- Treasury Securities are bonds issued by the U.S. Treasury Department.
Pros:
Low(er) risk because the investment is backed by the government’s complete faith and credit (vs other fixed income investments)
Cons:
When compared to other fixed income products, the lower risk comes with a lesser yield potential.
- Bonds issued by government institutions such as the HDMF, the Government National Mortgage Association (GNMA), the Federal National Mortgage Association, and others.
Pros:
Low(er) risk of default (similar with Treasury Securities)
Beneficial tax treatment
Cons:
Interest rate risk is a concern. If market interest rates climb above the bond’s face value, government bonds may lose value.
- Municipal bonds are bonds that are issued by municipal governments (LGUs).
Pros:
Low(er) risk of default
Low turbulence
Cons:
Interest rate risk is a concern. If market interest rates climb above the bond’s face value, government bonds may lose value.
- Bonds issued by public and private companies are known as corporate bonds.
Pros:
Higher returns than government-issued banks
Extremely liquid
There are numerous possibilities.
Cons:
When compared to government-issued bonds, there is a higher risk.
Bond Investing’s Advantages
- When compared to banks, it gives you a better return on your money.
- It can be used as an additional investing instrument to diversify your portfolio.
- Allows you to keep your money safe while still earning interest.
- Because it is less volatile than stocks, it is often thought to be safer (especially short and medium-length bonds)
- Bonds can be bought and sold (liquid)
- When a corporation falls bankrupt, bondholders often get a portion of their investment back (if not the full face value).
- There are various forms of alliances from which to choose.
How Can You Make Money From Investing in Bonds?
When the government or a private/public firm announces a bond sale, the first step for an investor is to buy bonds. The specifics of how you may buy them may differ, but the goal is to get in line as soon as the announcements are made.
Bond offerings are announced by the government and firms a few months before they are released, providing investors adequate time to make the required arrangements. Bonds generate income by paying interest on the face value (price of the bond) of your investment.
Coupon payments are periodic payments made to bondholders in exchange for “profits.” A firm, for example, may issue a bond with a 5% interest rate. Bondholders will get a portion of that 5% annual rate on a monthly or quarterly basis, depending on the chosen frequency.
Furthermore, because bonds may be traded, you have the option of selling them and profiting from a markup on your original purchase price. Some bondholders may prefer to free up funds sooner rather than later by selling the bond before it matures, offering them greater flexibility in their investing strategy.
Is Investing in Bonds Risky?
While there is no such thing as a completely risk-free investment, bonds are considered to be one of the least hazardous ways to grow your money. Aside from being less hazardous than stocks, it also necessitates less activity on the part of the investor.
The only real danger of investing in bonds is that the corporation that issued them will go bankrupt. Even if it’s uncommon, it’s still a potential and hence a risk.
However, there are measures built into the bond that will ensure that the investor receives some sort of payment in the case of a default.
