Investing in Bonds – What You Need To Know

Bonds, bonds, bonds … they’re everywhere at the moment. As the Treasury has got busy issuing billions of dollars in extra New Zealand Government bonds, the Reserve Bank of New Zealand (RBNZ) has been just as quick snapping them up.

In fact, the only Bond not showing his face at the moment is 007. No Time to Die, Daniel Craig’s final outing as Ian Fleming’s famous spy, has had its release date pushed back until November.

Like the reason for the blockbuster film’s postponement, the recent flurry of bond issues and purchases has been a reaction to COVID-19. In a time when government spending is blowing out, the Treasury and the RBNZ’s plans will not only raise extra billions for government coffers, they will release a whole lot more cash into the market, as we covered in our story What is Quantitative Easing And What Does it Do?

However, buying and selling bonds isn’t just for governments. Individuals can also purchase them, and many bonds represent a secure, lower-risk form of investment.

What are bonds?

Bonds are like IOUs used by a borrower to raise funds. They work in much the same way as a term deposit, offering a fixed interest rate over a set period, from six months to a decade and longer. Over the term of the bond’s life, the investor receives regular interest payments. Once the term period is over and the bonds reach maturity, the lender is paid back their initial investment.

However, unlike having money in a term deposit, where your money is locked up, many bonds can also be traded like shares.

Who can issue bonds?

Although we’ve heard a lot about central government bonds recently, local governments and private corporations can also issue bonds. The main bond issuers break down into four types:

• Central government: Treasury
• Government agencies: Housing New Zealand, NZ Post, etc
• Local government: Auckland Council, Christchurch Council, etc
• Corporate: ANZ, Contact Energy, Fletcher Building, Fonterra, SkyCity, etc

Trading bonds

As we mentioned above, many bonds can be bought and sold like traditional shares, through licensed sharebrokers and investment advisors. The NZ stock market’s NZX Debt Market is NZ’s primary market, with 144 different bonds listed.

An important exception to the trading rule is NZ Government Kiwi Bonds, which has this caveat in their standard disclosure statement: “The Crown does not intend to quote these bonds on a market licensed in New Zealand and there is no other established market for trading them.”

Fixed returns

One of the positives about investing in a fixed-rate bond is that if you plan to hold it to maturity, you’ll know from the outset what your return will be. It’s just like putting money in a term-deposit.

Things only become more complicated if you sell your bond before maturity and the market has changed. As interest rates rise and fall, the price of bonds fluctuates along with it.

For example, if you buy a $1000 bond paying 10% pa on maturity after 1 year, you will make $100 on your investment. (Remember, as with all investments, there are risks involved, but we’ll come to this later.)

But if interest rates go up and new bonds come on the market offering a 15% return, the market price of your bond will drop, so whoever buys it still makes 15% on their investment. After all, why would they buy it for $1000 and only make 10%?

Alternatively, if interest rates drop to 5%, the market price of your bond will rise, to ensure whoever buys it still only makes the new rate of 5% on the bond’s maturity.

Pros and cons

As with all investing, buying bonds isn’t something that you should enter into without professional advice, especially if you’re going to buy and sell them. All investment involves risk, and working out bond yields is a very complicated process that involves the kind of equations that you’d expect to see on a NASA whiteboard.

However corporate bonds can offer better returns than term deposits, without the volatility associated with the stock market. Government bonds tend to be the safest of all. Given the stability of our government and its good credit rating, for those seeking an alternative to banks and term deposits Kiwi Bonds could be an option.

But with less risk comes fewer returns:

Kiwi Bonds

Current Kiwi Bond rates for subscriptions of $1000 – $500,000 (correct at 14/5/20):

Term deposits

Current average term-deposit rates on www.canstar.co.nz (correct at 8/5/2020):

As the above rates show, stability does come with a cost. But, as part of a wider investment portfolio, bonds are a serious consideration for the more conservative investor.

If you are considering buying bonds, it’s also worth having a look at your current KiwiSaver options. What type of fund are you in, and does it meet your appetite for risk or growth? Many funds include bonds as part of their mix of investments, so you might already have some as part of your KiwiSaver.

To help you research the best KiwiSaver funds to match your investor profile, Canstar rates KiwiSaver providers for value and has a free comparison tool. To check out our KiwiSaver Star Ratings, click here … and for our comparison tool, just click on the big button below.

Compare KiwiSaver providers for free with Canstar!