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Should you add investment bonds to your portfolio?

Did you ever set up a lemonade stand as a child? Perhaps you borrowed money from your mother to purchase lemonade powder and promised to pay her back when the day was over. If your mom bought into your scheme, she essentially purchased an investment bond from you (but was probably kind enough not to charge interest). 

Think of investment bonds like “reverse” loans. When we think of loans, we often imagine an individual taking a loan from a bank. In the case of investment bonds, a corporation or government seeks a loan from the public. Buying bonds from a corporate or government entity is the same as loaning them money, with the promise of a return with interest.

What do investment bonds look like in practice?

Imagine a company needs cash in order to complete a new project. In order to finance their new project, they decide to offer investment bonds to the public. They might sell their bonds for $1,000 with an annual percentage return (or coupon) of 5% with a lifespan of 10 years.

This means that if you buy the $1,000 investment bond and wait until it reaches “maturity” (or the 10-year lifespan), you’ll receive $50 each year until maturity, along with your initial investment of $1,000 after 10 years. 

Varying interest rates on bonds

Depending on the risk involved with the company that sold you the bond, coupon rates may vary. The more risk the company has of declaring bankruptcy over the life of the bond, the higher the return rate will be. 

Although it is possible that an investor might not receive their total investment back at maturity, investment bonds tend to be more predictable and secure than stocks. Some bonds even have guarantees in place for a full return of your initial investment.

Read also: 8 investment opportunities to boost your finances

Unsure of the risk involved with a particular bond? It’s best to research each individual bond before purchasing it. If you want some help, bond rating companies assess the quality of different bonds. 

Just how secure is a bond?

The security of any investment depends on a number of factors. In regards to investment bonds, you may find the most secure ones are government bonds. However, just like any other asset, an investment bond’s value can fluctuate.

Even if a bond matures at the expected rate, there’s a chance that the interest rates could change within the economy. In this case, it may be wise to sell your bond early for a fraction of its potential worth at maturity in order to reinvest in a bond with a higher interest rate. 

For example, imagine you buy a 10-year investment bond from Company A for $1,000 with a 5% coupon. A year passes, and Company B offers a 10-year $1,000 investment bond with a 10% coupon. Company A’s total return is $1,500 over 10 years, while Company B is offering a total return of $2,000 over 10 years.

In this case, you may consider selling Company A’s bond for less than the purchase price of $1,000, as you stand to make more money by reinvesting in Company B’s bond. You would, of course, also have to take into account the risk associated with each investment to determine if the swap is worth it.

Although bonds are more secure and less volatile than stock, they don’t come without risk, especially when considering opportunity cost.

Should you consider investment bonds instead of stocks?

You could consider both! Although some stocks that offer dividends could be a great option, the returns on those stocks may not be as consistent or predictable. Bonds could be a way to diversify your portfolio. 

For more financial education information, check out other articles in our Academy library. 

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