Bonds, along with cash, stocks and real estate, are among the most common forms of investments. They are, however the least understood – and not nearly as exciting as stocks, which come with the greater potential gains, but bigger risks as well.  Cash investments, like GICs are popular because they are safe and real estate is, well, real.  It is a tangible investment with the added attraction that you can hang pictures on the walls and lounge there in your pajamas. (Kinda tough to do that with other investments.) Nevertheless, bonds really should be considered when rounding out your portfolio.

Bonds are also referred to as income investments because they provide a set rate of return for the investor when held to maturity. They are simply a type of “IOU” issued by governments and corporations in return for the use of your money for a set period of time.  The bond issuers then use the money to pay for such things as roads and infrastructure improvements, in the case of municipalities and other levels of government, and in the case of companies, to finance business operations.

Investors like bonds for their “Fixed Income”
Because they are typically (although not always) backed by large companies and governments, bonds are generally considered to be a safer investment than stocks. They are often assigned a lower to moderate risk level assuming you hold your bond until maturity.  Bond maturities can range from one to 30 years in length.  In return for that margin of safety, you earn a set amount of interest for as long as you hold the bond.  Investors like them because they know what their returns will be year after year. For example, a bond with the face value of $10,000 and an interest rate of 5% will pay out $500 a year in interest. Today’s 10 year Government of Canada bonds are paying about 3.5%.

Check the Ratings!
But bonds are only as strong as the company or government that backs them. There are organizations like the Dominion Bond Rating Service and Moody’s that give grades to various types of bonds. For example, S&P’s “AAA” rating implies the smallest degree of investment risk.  A “Triple-A” is very hard to come by and is reserved for only the strongest companies and governments. In assessing the various risk factors, the rating agency will have done an important part of your homework for you, but make sure you still check those ratings — and understand them — before you invest your hard-earned cash in any bond.

The other thing to keep in mind is that there is a lively after-market for bonds. Bonds are considered to be liquid which means they can be sold prior to the maturity date and are regularly traded on the bond markets.  The value of your bond will rise and fall in relation to interest rates so this is where the risk comes in.  If you sell your bond before the maturity date you could be subject to a capital gain (a good thing) or a capital loss (not so good!).

Do you Own and Bonds or Bond Mutual Funds?
Holding bonds (either by buying them directly through a bank or broker or holding them through mutual funds) can be good in two ways.  They give you diversification from the volatility of stocks and the returns are usually higher than savings accounts or GICs. Most people should have some bond investments in their RSP or investment accounts so check your accounts to see if you do. If you aren’t sure, talk to your financial advisor and use this as an opportunity to learn more about what you are invested in.

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