Given the extremely low rates of cash, people are searching for income. A lot of companies are promoting high-return bonds with 4%, 5%, or even 7% annual interests as great alternative investment options. It does look attractive and I was asked quite a few times recently.
I think it is better to list a few key factors of bonds below to help you make smarter choices when needed.
1. when investing in bonds, you are lending money to the bond issuers who agree to pay annual interests and your money back after the agreed terms.
2. Bond issuers are generally governments and corporations which borrow money for certain projects.
3. the annual interest of bonds is opposite to the credibility and reliability of the issuers. The lower the credibility, the higher the return to be offered to attract investors.
4. every bond has a credit rating. The lower the rating, the higher chance that the issuer will default without paying your money back when they should.
5. Therefore, Governments normally are reliable with higher credit rating, the return is lower, accordingly. Almost all high-return bonds are from corporations and have a lower rating than governments.
6. the bond can be bought and sold; the price does fluctuate which is opposite to the cash rate movements set by Reserve Bank. The lower the official cash rates, the higher the bond prices.
In short, no matter how a particular bond is painted as a safe or secure investment, be aware that high return means high risk, period. If you were to borrow money, why would you pay higher interest when you have great credibility and reliability?
Also, the cash rate is already at a historical low, the room for a bond price to move high is narrow, you won’t get much profit when selling it or even lose your capital if cash rates go up in the future.
Having said that, in some cases, if you understand well the project and purpose why a particular company borrows money by issuing bonds, you know with confidence that the project is a great investment to deliver good long-term returns. It would be a great investment opportunity that your money will be paid back later and getting paid a high return every year.
As always, feel free to reach out if you have any questions or need to discuss certain issues.