The "Bond" Investment.


When I first learned about investing, I thought you could only buy individual company stocks or bank instruments.

Subsequently and in an interesting way in my childhood, I was introduced to this new asset class altogether which was paying me a certain amount (higher than bank FDs)  periodically and was much more secured than equities. 

Yes, you might have guessed it by now I am talking about "Bonds".

Several times during my childhood, my grandparents decided to give me government bonds as part of my birthday present and  I was inquisitive to know more about it but my curiosity was killed by telling me it isn't a thing for kids. 

At the time, I definitely didn’t understand what the phrase "face value" or "YTM" or "Cupon" meant or why I couldn’t use these official-looking pieces of paper. 

I guess more video games and clothes could be a better option back then. 

Cut to few years, as the value of those decades-old bonds has matured, I started reaping the benefits of the investments my grandparents made.

And I started to ponder Was this something I should invest my current portfolio in? 

Fascinating Abhinav but why are you sharing it? Just tell the ways to improve our financial well being, will you? 

Well, let's get to the point then. 

Want to strengthen your portfolio's risk-return profile? Adding bonds can create a more balanced portfolio by adding diversification and calming volatility. 

But the bond market may seem unfamiliar even to the most experienced investors. Many investors make only passing ventures into bonds because they are confused by the apparent complexity of the market and the terminology. In reality, bonds are very simple debt instruments. 

So how do you get into this part of the market? 

Worry not this is what this article is all about understanding the basics terms about the bonds, ways to invest in bonds and yes should you invest in bonds or debt market. 

Well to start with a bond is nothing but fixed-income security that allows you fixed interest for a certain period and/or capital appreciation. 

Unlike stocks, which are purchased shares of ownership in a company, bonds are the purchase of a company or public entity’s debt obligation.  Instead, a bond is a loan to a company or government that pays you a fixed rate of return over a specific timeframe.

Before we get into the characteristics of the bond let's understand where are these bonds can be bought from:

There are two different “exchanges” that enable investors like you to purchase or trade bonds:

Primary Exchange – with this exchange, think of a larger investment. This is where an initial offering of bonds is made. A bank or larger institutional investor will typically purchase bonds and might later distribute to investors for a set price. So it’s probably not for your typical investor, but for a larger organization.

Secondary Exchange – after this initial offering of a company or government entity, a bond can now be purchased over the counter. This is how retail investors like you and me get to purchase the bonds. 

Also included in this secondary exchange category, you can buy into bonds through mutual funds that include bonds in their make-up. That's what basically your debt mutual funds are. 

Now we know the markets for the bonds. let's understand some simple terms: 

Market price: it is the amount at which the bond is currently available at the secondary market for the sale/ purchase. 

Par value/ face value- It is the amount that you will be getting per bond at maturity. 

Maturity: This is the date when the principal or par amount of the bond is paid to investors and the company's bond obligation ends. Therefore, it defines the lifetime of the bond. 

Coupon: Refers to the interest paid per period. It is generally annually or semi-annually. 

Yield: It refers to the actual or effective return from the bond. 

Alot of the time investors tend to confuse between coupon of the bond and the yield of the bond. coupon that is the interest paid by the bond is not same as the yield that is the return generated by the bond. 

The current yield compares the coupon rate to the current market price of the bond. Therefore, if a Rs.1,000 bond with a 6% coupon rate sells for Rs.1,000, then the current yield is also 6%. However, because the market price of bonds can fluctuate, it may be possible to purchase this bond for a price that is above or below Rs.1,000.

If this same bond is purchased for Rs. 800, then the current yield becomes 7.5% because of the Rs. 60 annual coupon payments represent a larger share of the purchase price.

Now that we know what the bonds are and how they work. 

The big question that comes to mind is should you invest in the bonds or not? 

Well, there can't be a single piece of advice for this question that can be generalized for everyone. It will depend on various factors like the current opportunity in other asset classes like equity, your risk profile, your overall equity to debt ratio, and your requirement if its short term or long term. 

However, In constructing a portfolio, fixed income instruments are usually seen as short-term stabilizers that protect the downside of a long-term portfolio dominated by stocks and real estate. Hence, having a 10-30% portfolio allocaton in bonds even in a really long-term focused portfolio can be a good strategy.

Also before investing in the bond either directly or through the bonds, it is important to understand the risk associated with these investments. 

Well, the risk associated with the debt investments is already covered by me in one of my previous posts. Highly recommend going through the same - Debt risk

Since bonds are long-term investments, the maturity value is realized only if the bond is held until maturity. If you want to exit earlier, you can trade the bond in the secondary markets but this requires knowledge of the bond markets and a keen eye on interest rate movements.

An alternative way is to invest in bond funds. Bond funds are mutual funds that invest in different bonds as per the fund’s theme. This takes away the burden of having to analyze bond price movements or market rates. 

However, a note of caution is relevant here. There is a human element in the management of bond funds: the fund manager. It is advisable to invest in bond funds managed by fund managers who have been in the business for a long and have a track record of consistently profitable returns from the funds managed.

Note: Views expressed above are solely the author's perspectives. Readers are advised to keep their discretion insight and consult their financial advisor before making any investment.


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