In considering your investment options, it’s worth noting that corporate bonds can be a good investment vehicle as are stocks, treasury bills, and CDs. You may not, however, fully understand the benefits of corporate bonds and why they make a fitting choice for a diversified portfolio.
This post highlights the most important points about Corporate Bonds so you can make the right investment choice. In this post, we will answer:
- What are Corporate Bonds?
- What Is the Return on Corporate Bonds vs Other Investments?
- How Do You Purchase Corporate Bonds?
- How do Corporate Bonds fit into my portfolio?
- How to choose a Corporate bond?
What Are Corporate Bonds?
According to the Australian Securities and Investments Commission,
“Corporate Bonds are a way for companies to raise money from investors to finance business activities. Companies that issue bonds promises to pay you interest at regular intervals and return your investment or the full bond value on a given maturity date.”
When you purchase a bond, you are in essence making a loan to the company issuing the bond.
You give the company a specific amount of money with a defined maturity date just like a bank may give you a car loan. The bond may include regular coupons or interest payments and you receive the full face value when the bond matures. You can also think of the bond as an IOU that includes regular distributions with the final payment provided as a lump sum.
What Is the Return on Corporate Bonds vs Other Investments?
The ASX explains that corporate bonds offer a better return on your invested money than cash, term deposits in a bank, or government bonds but less than stocks.
Corporate bonds are also a safer way to invest in a company than buying shares. Unlike stocks where the value may rise and fall dramatically with the market, a bond has a guaranteed rate of return as long as the company stays in business.
How Do You Purchase Corporate Bonds?
Many people do not realise that purchasing corporate bonds can now be as simple as buying and selling a share of stock.
You can buy corporate bonds through a public issuance on behalf of the company, AKA the primary market. These offerings of corporate bonds are usually only available to wholesale investors (loosely defined as someone with more than 2.5M in assets). Although there are primary offers available for retail customers (everyone else).
How do Corporate Bonds Fit into my Portfolio
Until recently, corporate bonds were “the domain of institutional or ‘sophisticated’ investors” and most individual investors shied away from them.
Recent changes in security regulations now make bonds more accessible to all investors.
Most financial advisors suggest that a client adds bonds to their portfolio for the following reasons:
- Steady Income – Coupon payments or interest payments occur on regular dates and are a good source of steady income for retirees
- Capital Preservation – Because they are more stable than stocks, corporate bonds provide a higher level of stability
- Portfolio Diversification – All bonds, including corporate bonds, are considered a “defensive asset” and are less subject to the ups and downs of the market
The Benefits of Corporate Bonds
- If the company issuing the bonds goes bankrupt, corporate bondholders are paid before stockholders so there is less risk
- Corporate bonds often provide a steady stream of interest income
- Corporate bond prices are less volatile than shares of stock
The Downside of Corporate Bonds
- Corporate bonds are not a growth investment and there is capital growth only with a few inflation linked bonds
- Corporate bonds offer less flexibility than buying and selling shares because there are many more companies offering shares than companies offering bonds.
How to Choose a Corporate Bond
Investors usually consider both the potential yield and the risk associated with a bond before making a decision. Higher yield can come with higher risks so each investor must balance the potential rate of return with their appetite for risk.
Weigh the importance of monthly income payments vs. quarterly or annual payouts and consider how the maturities of different bonds fit into your retirement and travel plans.
Creating a Solid Portfolio with Corporate Bonds
The Australian Bond Exchange provides additional information about how corporate bonds can complement nearly every investment portfolio. Corporate bonds provide an excellent way to:
- Earn regular income by loaning money to Australian-based companies who offer a guaranteed rate of interest, paid out at regular intervals.
- Protect your capital by purchasing corporate bonds through the Australian Bond Exchange.
- Purchase a safe and secure alternative with less risk and a typical return of around 5.2% compared to bank deposits or term deposits returning less than 3.2%.
- Diversify your investment portfolios with less risk
Corporate Bonds provide regular, consistent payments at rates well above those offered by most banks. You receive a regular automated income stream with far less risk and avoid the volatility associated with buying and selling shares of stock.