Bonds are low-risk investments that can add balance to your portfolio of stocks and help you establish a fixed income as you near retirement. Many of the safest government and corporate bonds can all but guarantee you’ll get your initial investment back – plus interest distributed throughout the life of the bond.
Buying bonds in Canada is similar to buying stocks, but with some notable differences in how they’re assessed. ABelow we’ll delve deeper into bond buying and offer some guidance on how you might add them to your investment strategy.
What are bonds?
A bond is a fixed-income investment that’s issued by corporations and governments to raise money for business ventures.
In this way, bonds are essentially loans. You lend money to a company or government body with the promise that they’ll pay back the principal – plus interest.
Because of this promise, bonds are typically less risky than stocks. Less risk, of course, means less potential for higher returns: bond payouts are generally less promising than the long-term growth of stock investing. That said, most bond investors are willing to trade higher gains for the stability and higher long-term returns that bonds promise.
Types of bonds
Though all bonds work in more or less the same way, they differ by who issues them (government or corporation) and the financial stability of that entity (its grade or risk). The following three are the most common types of bonds you’ll encounter in Canada:
Government bonds
These bonds are issued by the Canadian Federal Government and are the least risky of all bonds. Government bonds pay twice per year (every six months) and come with terms that range from one to 30 years.
Provincial and municipal bonds
These bonds are also issued by a government entity, but in this case, it’s the governments of provinces, cities, and towns. Like government bonds, provincial and municipal bonds are considered ultralow risk investments, though they have slightly more risk than those issued by the federal government.
Corporate bonds
These bonds are issued by corporations and businesses. They’re riskier than government bonds, as businesses are more vulnerable to insolvency than governments, but they typically have higher interest rates. Corporate bonds themselves are separated into two classes, which can help you assess their risk:
- Investment-grade corporate bonds: The companies that issue these bonds are generally at low risk of defaulting. They have at least a BBB (from Moody’s) or a Baa3 (from Fitch and S&P).
- High-yield bonds: The companies that issue these bonds are generally at a higher risk of defaulting. Because they have a higher risk, they will offer higher returns.
Benefits of investing in bonds
Although bonds have lower potential returns than stocks and other equity investments, they have some amazing benefits. Here are five reasons why bonds make a good investment:
- Predicable income stream. Most bonds pay twice per year. This can give investors a reliable stream of passive income.
- Bond ladders can provide higher returns. A bond ladder is simply a string of bonds with maturity dates that expire one after the other. For instance, you could have one-year, two-year, and three-year bonds. The bonds with shorter terms ensure against having all your money wrapped up in illiquid investments, while those with longer terms help you capitalize on better interest rates.
- Principal is (almost) guaranteed. Government and most investment-grade corporate bonds are considered safe investments, as the entity backing them isn’t likely to become insolvent.
- Less volatility than stocks. Stock prices fluctuate daily, hourly, and even by the minute. Many bond yields – once purchased – are fixed and will pay out at a steady rate.
- Better yield than most bank products. Though bond yields can’t compare to the gains on some stocks, they are usually higher than GICs and savings accounts.
How to buy bonds in Canada
Bonds are not traded on major stock exchanges, but you can buy them through a financial institution (like your bank) or a broker.
Many banks and brokers will provide you with a list of bonds you can buy. This list will also include a few important keywords that will help you decide which bonds fit best with your investment strategy. Some of these keywords include:
- Coupon rate: This is the annual interest rate the bond pays out. For instance, it could be 5% or 6%. Most bonds will pay interest semiannually (twice per year), but some will also pay quarterly or monthly. These rates can be fixed or variable.
- Maturity date: This is the date when the bond issuer will repay what they initially borrowed. If you paid $1,000 for a bond, then the bond issuer will pay $1,000 at this date. Note: You can sell a bond before its maturity date to another investor, especially if the coupon rate is fixed and higher than current rates.
- Face value: This is the amount the bondholder receives on the maturity date. Again, if the initial price of a bond is $1,000, then the face value is $1,000.
- Bond rating: This indicates the financial strength of the bond issuer. The higher the rating, the safer the bond.
When you’ve decided which bond has the right qualities for you, you can place an order with your broker or bank. It’s important to note that brokers will likely charge trading fees to buy or sell bonds. To save money on fees, then, it’s best to buy bonds in bulk, rather than piecemeal. You might also need to have a minimum investment to buy bonds (such as $10,000).
Although you can’t buy individual bonds on stock exchanges, you can purchase bond ETFs through your online brokerage account. These ETFs will unify dozens and dozens of different bonds within one investment. Bond ETFs have fund managers who will buy new bonds to replace those that have matured, as well as distribute bond payments (usually monthly) to shareholders.