Low-down on bond investing
PROS: YOU’RE PROTECTED FROM BAD TURNS
These instruments are good for people who want to take very little risk, but still earn money.
Isn’t it strange that debt can be an investment? Unfortunately, we don’t mean the kind of debt that gets you the latest threads. It’s actually more accurate to say lending money to someone else can be an investment.
How can debt be an investment?
When you borrow money from the bank, you don’t only pay back the amount you borrowed. In exchange for giving you the money when you need it, the bank charges a fee and interest. That is how the bank makes money.
If you lend money to your friend, you can ask them to pay you a small fee for every month they don’t pay you back. When they do pay you back, you get the original amount they borrowed as well as that fee. Your money earned more money, which makes it an investment!
What does this have to do with shares? There is a special type of share that companies or the government sell when they want to borrow money. When the government wants to borrow money, these are called bonds. If it’s a company borrowing money, the shares are called corporate bonds or preference shares.
How are bonds different from shares?
The price of a share changes depending on how well the company is doing. If you bought a really good share, the price can go up over time and you can eventually sell it for more than you paid for it. You can also earn dividends on a share.
Bonds are more like lending money to a friend. The company or government that sells this certificate tells you when they will pay you back and what fee they are willing to pay to borrow money from you. The fees are usually paid out to you in intervals over the loan period, for example every three months until you get back the full amount borrowed.
Why would I want to buy a bond?
Bonds are considered a safe investment, because you are very likely to receive back your original loan and the fee for lending the money. If something goes wrong with a company that borrowed money from you, the company is required by law to pay you back before worrying about shareholders who bought ordinary shares.
While you are protected if something goes wrong, you don’t benefit when things go well. You will always only receive the amount you agreed to when you bought the bond, even if the company’s ordinary share price goes up. Bonds are a good investment for people who want to take very little risk, but still want to earn some money.
What does the government have to do with it?
Governments all around the world borrow money from their citizens. Governments can issue bonds through the exchange, like companies, or they can issue bonds directly to the public. In South Africa, you can buy Retail Savings Bonds directly from the National Treasury or the SA Post Office.
This article was first published on Just One Lap