Investing in bonds
- Safer than investing in shares
- Coupons paid at regular intervals
- Typically higher returns than savings accounts
What are bonds?
When you buy a bond, you are actually lending money to a company or a country. In return, you will receive annual interest. After a certain period, the bond expires and you will normally get your lent money back.
If the bond is issued by a company, it is called a corporate bond. If it is issued by a country, it is called a government bond, also known in Belgium as ‘state notes’. There are also savings certificates, in Belgium, where you effectively lend money to a bank.
What returns do bonds offer?
Bonds are an interesting investment if you are looking for a higher return without taking a lot of risk. They typically offer a better return than a traditional savings account, whilst offering greater security than shares.
For instance, most bonds offer a fixed interest rate in the form of periodic coupon interest. Put simply, this is the pre-determined amount of income you receive at regular intervals. So you know from the start precisely what income you can expect to receive each quarter or each year. Though there are also some bonds which have variable interest rates.
A bond is still an investment and is therefore not entirely without risk. Companies and countries could go bankrupt or lack the means to pay the coupon interest or to pay you back.
What are the costs and risks associated with bonds?
The issue price varies from bond to bond, as it is determined by the company or country issuing the bond. Besides paying a commission, you also pay withholding tax on the interest you receive (usually at a rate of 30% in Belgium).
Keep the following risks in mind when investing in bonds:
- Credit risk: what happens if the bond issuer goes bankrupt? The bond issuer is the party - a country or company - to which you effectively lend money in exchange for a bond. What happens if that country or company goes bankrupt? In that case you will be at the end of a long line of creditors (but ahead of the company’s shareholders). In practice, it will be difficult to recover your investment.
- Liquidity risk: what happens if you want to sell before the bond matures? Investors wishing to sell their bonds before they mature will have to sell them at a price determined by the professional counterparty, which then acts as the buyer or, if necessary, the seller. This calculation will be based on the prevailing market conditions at the time, which means the price could be lower than the original purchase price.
- Early redemption: what happens if the issuer wants to redeem the bond early? In the case of 'callable bonds', a company can choose to redeem your bonds early. You will then receive your initial capital plus the interest that has accrued up to that point. Not a bad deal, you might think. However, if you subsequently decide to invest your money again, interest rates may suddenly be a lot lower, with bonds now offering a return of just 4% per annum instead of the 10% you had been guaranteed before. To compensate for this risk, the issuer’s right to early redemption usually comes with a slightly higher coupon.
- Market risk: what happens if market conditions change? There are always general risks involved in investing. Interest rates and exchange rates can change quickly. Like any other entity, companies – and thus all bond issuers – are not protected from all the possible surprises that markets can trigger. Therefore, all forms of investment involve a certain amount of market risk.
- Exchange rate risk: what happens if you buy bonds in other currencies? If you invest in bonds denominated in a currency other than the euro, you risk losing some of your money if the exchange rate is unfavourable at the time you want to convert your money back to euros.
How to invest in bonds
You can invest in a range of different bonds through KBC. The first thing to do is to make an appointment at your nearest branch or take a look at the current available bond issues.
