Your clients are almost certainly familiar with equities and how they can generate an income in retirement. However, they probably know very little about the role that corporate bonds can play in mapping out fixed income streams in retirement planning. Yet these instruments feature heavily in the financial plans of US and European investors because they can generate a regular and more stable flow of income than equities.
To get down to basics, corporate bonds are best thought of as IOUs, where a company borrows an amount of money, say AUD1000, and promises to pay back the entire sum at a certain date in the future, e.g., 5 or 10 years.
During the intervening period, the issuer of the bond promises to pay the investor a sum of money, known as a coupon, at regular intervals – every 6 months or every quarter. The amount of the coupon is established when the company issues the bond. So, if the company promises to pay 6% on that AUD1000, the borrower knows they will get AUD60 every year for 10 years, i.e., AUD15 each quarter or AUD30 every 6 months for 10 years. The income does not vary – hence bonds are also known as the “fixed income” asset class.
Contrast that with equities, where dividend yields can fluctuate sharply – and can even be suspended – depending on the fortunes of the underlying business, and you can see why corporate bonds are so popular with US and European retirees seeking a regular, dependable income.
Just like equities, bonds are liquid instruments, so an investor can always sell their holding if they wish. The price of bonds, once issued, is influenced by a number of factors, including the general level of interest rates in the economy. But that regular fixed coupon (and the obligation to repay the face value of the bond at the end of the bond’s term) explains why bond prices tend to be much less volatile than equity prices. Indeed, they can anchor a portfolio during periods of volatility in equity markets. That is also an important advantage for older investors seeking as much certainty as possible from their finances. Equities, on the other hand, provide much greater growth potential, which is why they are maybe more advantageous to younger investors with a longer time horizon.
To make a direct comparison, consider the income delivered by some of the bonds on the ABE platform, compared to the dividend yield offered by the corresponding stock (correct as at 16th June 2023). Take the Rakuten Group Inc., a global leader in internet services based in Tokyo, Japan. Its bond offers a yield of 6.5% pa, while the dividend yield of the stock listed on the Australian Securities Exchange offers 4.5% pa. So, while stocks offer better growth prospects, bonds can deliver a higher income.
That is just one example. Using the Australian Bond Exchange you can help your clients build a diversified portfolio of bonds, generating income at different dates, so they are assured of receiving a regular and stable income throughout the year.
Disclaimer: Australian Bond Exchange Pty Ltd ACN 605 038 935 AFSL 484453 (ABE). This article is intended to provide general information of an educational nature only. It does not constitute the provision of personal advice and does not take into account your personal objectives, financial situation or needs. Before investing with ABE, you should consider the appropriateness of the investment to your particular financial and taxation situation and consider obtaining independent advice before making an investment. Examples in this article are for illustration purposes only and are not a recommendation to buy, sell or hold a particular investment. ABE makes no representation or guarantee as to the availability of a bond with the characteristics described in this article or that an investment made by you will generate the returns in the illustration. Past performance is not an indication of future performance. Investing with ABE is subject to our Client Services and Custody Agreement Terms and Conditions and Financial Services Guide.