Investing in bond funds – recommendations, how to buy bonds?
Investing in bond funds – types, recommendations, how to buy bonds?
Investing in bond funds is it worth and what can you count on?
Bonds can be called a reliable tool for obtaining stable passive income with insignificant trading risks. In fact, it is an issue asset, giving the holder the right to demand from the issuer (the organization or entity that issued the bonds) the property or financial equivalent of the par value of the security within the prescribed period. With active independent trading of stock assets, bonds can become a reliable tool for risk diversification. It is also advisable to consider such assets as ordinary users as an alternative to a bank deposit. The main advantage of bonds compared to other stock assets lies in their predictability, that is, potential profit can be accurately calculated even before the acquisition of securities.
Bonds can also be called a kind of debt receipt, that is, by purchasing these securities the investor becomes the issuer’s creditor, for which he receives a commission for the entire term of ownership of the securities. The body of debt is paid in due time in full.
The presented article is aimed at beginning investors and is aimed at solving the following problems:
- Explain the features of bonds of various types and the appropriateness of the acquisition.
- Provide effective advice on compiling a diversified investment portfolio.
- To draw the attention of interested users to the “pitfalls” and provide step-by-step guidance on the acquisition of bonds.
Having fully studied the material presented, everyone will be able to create an additional source of passive profit, the level of which will be limited only by the amount of starting capital. In fact, the profit potential is not limited and the correct structure of the investment portfolio, with the use of interest capitalization, is almost guaranteed to meet expectations.
Types of bonds
Bonds are usually divided into several types and categories:
1. By type of issuer, such assets are divided into:
- government – issued by the highest government financial institutions, for example, in Russia, the issuance of government bonds is mainly carried out by the Central Bank of the Russian Federation;
- municipal – published by local regional authorities to attract private investment;
- corporate – issued by legal entities;
- foreign – published by foreign companies and government agencies.
2. Bonds are usually divided into groups by maturity:
- short-term – the period of ownership of the asset does not exceed 1 year;
- medium-term – bonds are issued for a period of 1 to 5 years;
- long-term – purchased for a period of 5 years;
- perpetual – the time limit for the payment of the invested amount is not set, however, such a payment can be obtained by selling the asset at nominal value to third parties on specialized trading floors.
A vivid example of perpetual bonds can be called US government debt. The use of bonds of this state is considered to be a reliable tool for preserving accumulated capital and diversifying risks.
3. Bonds are divided into 2 groups depending on the nature of the appeal:
- convertible (subsequently, the asset can be exchanged for shares or other property at an equivalent value);
- non-convertible (the investor has the right to only sell the asset on a specialized trading floor, or to receive payment of the invested amount from the issuer on time).
It is worth noting that convertible bonds are issued mainly by legal entities.
In addition to the mentioned criteria, bonds are also registered and “bearer”. In the first case, only the investor has the right to sell the asset. Most bonds are issued just “bearer”, that is, any bearer of the asset can demand the issuer to return the investment in full, taking into account the accrued interest, by the due date.
How much can you earn by investing in bond funds?
The yield of bonds depends primarily on the type of asset. By the way, debt receipts are also usually divided according to the form of payment of profit to investors:
- Coupon bonds. Their obvious advantage is a fixed interest rate, which cannot be changed during the entire period of ownership of an asset. It is worth saying that US government bonds are the most attractive precisely because they provide for fixed income for an unlimited period. Such assets are not registered, therefore, if desired, the investor will be able to get a nominal value by selling securities to third parties. Today, the yield on US coupon bonds is 3% per annum in dollars, which exceeds the interest rate on bank deposits in foreign currency. To evaluate the profitability of investing in US debt receipts, it is enough to recall that investing in foreign currency by default guarantees protection against inflation.
- Bonds with a floating interest rate. Such securities can be issued both by government agencies and legal entities. The return on these assets is usually determined by a specific macroeconomic indicator. Large companies often tie the level of profitability of such bonds to the value of net assets, and the potential profit of government securities depends on the performance of a particular macroeconomic or stock index.
- Mixed asset type. During the ownership of securities for a certain period, the investor will receive a fixed profit, during another period – a floating profit. Considering the purchase of such securities to diversify the investment portfolio is impractical.
- Discount bonds. Issued mainly by corporate organizations. This type of bonds differs from the previous ones by the absence of the issuer’s interest payments, however, it is important to note that such assets are sold at a cost that is 15-30% lower than the nominal. Within the established period, the investor has the right to demand payment of the par value of bonds from the issuer. Such securities can be sold independently on the stock exchange, but the profit level in this case will be significantly lower.
Investment portfolio guidelines and return potential
How much can you earn by investing in bond funds? As mentioned earlier, experienced investors and stock traders see bond purchases as a tool for risk diversification. Fixed income coupon government and corporate bonds are in special demand.
When compiling an investment portfolio, large investors such as Warren Buffett and George Sorros are guided by the following principle – 70% in shares and 30% in bonds, that is, 30% of capital should consistently bring fixed income from bonds. The remaining 70% should be distributed in the following ratio: 50% of the capital should be distributed between shares of companies with high capitalization (it is also advisable to consider mutual or ETF funds and stock indices) and dividend yield, and 20% should be allocated to shares of young enterprises with high growth potential. This is the optimal structure of the investment portfolio, which will allow you to get a relatively high profit with moderate and even conservative risks. Thus, passive profit will be based on:
- Receiving fixed income from coupon bonds in the amount of 3 to 15% of the invested amount.
- Dividend payout. The level of profit is determined by the board of directors and is difficult to predict. The value of dividends largely depends on the value of the company’s net assets and financial results at the end of the reporting period.
- Growth in stock prices. Large organizations with high capitalization show a small but steady growth of 5-12% per year. More interesting in this regard are young, but promising enterprises, which are characterized by a rapid increase in the value of shares with the successful sale of the product. The growth potential is unlimited.
Approximate calculation of potential profit
- According to statistics, the average starting capital of a novice investor is 1000 USD, therefore, it will be distributed as follows:
- 300 USD – coupon bonds with a fixed yield, for example, 10% per annum;
- 500 USD will need to be distributed between the assets of reliable companies with high capitalization (Google, Microsoft, Apple and others) with growth potential, for example, 10% per year + dividends credited;
- 200 USD is invested in 1-2 young enterprises with high growth potential.
Suppose that the assets were chosen successfully and the growth in the value of shares of young companies amounted to 100% per annum. Thus, the passive annual earnings of a novice investor will be approximately 1,100 USD.
Active intraday trading in stocks has a greater profit potential – up to 10% per day using the broker’s leverage, however, such trading tactics are associated with high risks and require deep knowledge in the field of audit of commercial enterprises, macroeconomics and directly experience in working with the trading platform and price graphs.
How to buy bonds and investing in bond funds?
In accordance with current legal standards, each individual has the right to purchase securities in order to make a profit, however, for this it will be necessary to use the services of an intermediary company – a broker. Some organizations provide the opportunity to open an account online, but in most cases a personal presence of a client at the company’s office is required to conclude an agreement and deposit funds.
Important! Unlike trading on the OTC market, transactions on the stock exchange virtually eliminate non-trading risks due to the reliable regulation of brokers by government agencies. An investor can lose part of the deposit only under the influence of market factors.
After concluding a contract at the broker’s office, the trader receives authorization data on the company’s website and access to download special software. It is worth saying that today some companies are actively promoting special mobile applications for investors, allowing to realize almost any trading ideas in a couple of clicks.
In such applications, in the form of a table, a complete list of bonds available for purchase is presented, their nominal value and yield are indicated.
Beginning investors are advised to pay attention to the acquisition of assets of little-known companies due to their high profit potential and relatively low cost.
All transactions in mobile applications or in the broker’s web terminal are completed within a few seconds. It is also possible to open transactions by phone. Bonds will be sold automatically at the scheduled time.