Investing in bonds
Bonds are a type of loan that you give to a company or a government. Investing in bonds is usually low risk and meant for the long term. The returns can still be good and are often better than keeping money in a savings account. After stocks, bonds are probably the most well-known type of investment.
Please note: trading in bonds on the financial markets involves risks, you can (partially) lose your investment.
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What are bonds?
When you invest in a bond, you are lending money to a government, bank, or company. They may use this money for new projects, daily operations, or to pay existing debts.
The bond includes an interest rate, also called the coupon rate, and a maturity date, which is when they must pay back the loan. As a bondholder, you mostly earn money through interest payments. You can also make money with bonds that are listed on the stock exchange by selling them before the maturity date if their market value has gone up.
How to invest in bonds
To invest in bonds that are listed on a stock exchange, you cannot go directly to the company or government that issues them. Instead, you need to open a brokerage account with an online broker. A broker is a platform where you can buy and sell different types of investments, such as stocks, funds, and bonds, to build your investment portfolio.
Below, you will find popular brokers for bonds:
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Invest in over 1 million stocks, ETFs, bonds, and other instruments across U.S., European, and Asian markets. Explore predefined selections of high-yield ETFs and bonds with potential dividend returns of up to 6% in EUR. Utilize in-house market research and weekly investment ideas.
Invest through this European broker in stocks, ETFs, and crypto. Transactions in iShares ETFs and investment plans are free; other trades cost 0.99 euros. With Prime+ (4.99 per month), trades from 250 euros are free. Uninvested funds earn an expected return of 2.25%.
Types of bonds
You can invest in European government bonds, corporate bonds, or bank bonds. Government bonds are seen as the lowest risk because they usually offer steady interest payments and loan repayment. Corporate bonds carry more risk, as the returns depend on how well the company performs. If the company does badly, your returns could be lower.
Government bonds are the lowest in risk.
Bank bonds, like government bonds, are also seen as low-risk. However, banks can still go bankrupt, just like companies. If a bank is close to failing, the government can choose to stop interest or loan payments to help save the bank. This is called a bail-in and means you lose part or all of your returns. Still, this does not happen often.
Listed vs. non-listed bonds
You can invest in listed or non-listed bonds. Listed bonds are traded on public markets like Euronext or the Frankfurt Stock Exchange. Their prices change based on interest rates and market demand. You can sell them at any time the exchange is open, but the price might be higher or lower than what you paid.
Non-listed bonds are not traded on a stock exchange, although there are other online platforms that offer them as an investment opportunity. However, they are usually not traded between investors. Because of this, they do not have a market price, and you often have to hold them until the end date. They can offer higher returns, but they also carry more risk and are harder to sell early.
Alternative bonds
Aside from the main types of bonds, there are also alternative bonds. For example convertible bonds. These bonds can be changed into shares of a company. They give a fixed interest rate, but also give you the chance to become a part-owner of the company later on.
This type of bond is most profitable when the stock price becomes higher than the value of the bond plus the remaining interest payments. The number of shares you can receive is set in advance.
Perpetual bonds have no maturity date and can be seen as equity instead of debt.
Perpetual bonds are another type of alternative bond, also called consol bonds. These bonds have no maturity date and are more like equity than debt. A perpetual bond gives interest payments without an end date, but the loan itself is never paid back. That is why it is important to only invest in perpetual bonds that are financially strong. This type of bond is similar to receiving dividend payments.
Another example is subordinated debt, also known as junior security. This bond is only paid after all other company debts have been repaid. It is more risky than other bonds. If a company goes bankrupt, other debts get paid first, and you might not get your money back. Because of this risk, subordinated debt usually offers higher interest rates.
Open an account directly with eToro, a large European broker, or with Freedom24, which offers a range of one million stocks, ETFs and options. Investing involves risks. You can lose your investment.
The market rate of listed bonds
Several factors can affect a bond’s market value. For listed bonds, short-term bonds usually change less in value than long-term bonds. Long-term bonds react more strongly to changes in the market.
Also, when general interest rates go down and savings accounts become less attractive, bond prices often go up. In other words, when bank interest is low, bonds can offer better returns.
Another reason a bond’s market value may rise is when the issuer’s credit rating improves. This means there is a lower risk of not being repaid. Public trust also plays a role. For example, during the European debt crisis, many investors were unsure if countries like Greece, Spain, and Italy could repay their debts. Because of this, the value of their bonds dropped sharply.
Risks
Bonds are seen as a low-risk investment compared to investing in stocks. But this does not mean they are without risk.
Because the interest rate is set in advance, the returns are usually stable. However, listed bond prices can still change. If a company has financial problems, it might stop payments. And if the issuer goes bankrupt, you could lose part of your investment.
Even though bond investing is fairly safe, it is still smart to spread your risks. With corporate bonds, you can invest in different sectors. You can also choose bonds with different durations. Since you cannot always sell a bond whenever you want, having different maturity dates can help limit losses if one bond performs badly.
It is also a good idea to invest in both bonds and stocks. These two types of assets usually move in opposite directions: when one goes down, the other often goes up. That is why bonds are often used to balance a stock portfolio and reduce market swings.
Returns
Bond prices can change, but the main return from bonds comes from fixed interest payments. As long as you hold the bond, you will receive these payments regularly, usually twice a year. This gives you a steady income. You can also choose to re-invest these returns to grow your investment over time.
Returns mostly come from interest payments, but you can also sell a bond before the maturity date to make a profit.
Compared to stocks, bonds usually give lower returns over time but come with less risk. According to Morningstar investment research, long-term government bonds have given about six percent per year since 1926. The return depends on the type of bond and how long it runs. In general, long-term bonds offer higher interest payments.
Besides interest, you can also make money by selling a bond for more than its original value. This happens when the bond’s market rate goes up. The next paragraph explains what affects a bond’s market value.
Bond funds and ETFs
Many people buy bonds as a long-term investment to grow their returns over time. Instead of buying single bonds, it can be useful to invest in a mutual fund or an Exchange Traded Fund (ETF).
When you invest in a bond fund or ETF, you do not need to be very active. These funds manage the buying and selling of bonds for you and spread the risk by including many types of bonds with different lengths and conditions.
Funds and ETFs automatically spread the risk for you.
With bond funds, the interest you earn is usually paid out as dividend. If the value of the bonds in the fund goes up, you receive those extra profits once a year. This gives you a more regular income than individual bonds, which often pay interest only twice a year.
Keep in mind that both funds and ETFs charge service fees. In general, ETFs have lower costs because they are usually passively managed by following a market index. Mutual funds are often actively managed, which means someone is making investment decisions, and that costs more.
