Back to Basics: Investing in Bonds

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Kita Mo
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Investing in bonds has indeed served as one of the most rewarding ways of growing your money. However, for those who have yet to experience it, there are a couple of factors that they need to consider before pursuing this type of investment. 

What is a bond and why should you invest in it?

When governments, corporations, and other entities need additional capital to finance their projects or pay other loans, they can generate these funds by selling bonds to the public. Bonds are liabilities incurred by large institutions and owed to bondholders. Institutions usually issue bond certificates containing payment agreements and interest rates to investors to serve as proof that they have an obligation to pay a debt to these individuals.

Companies and other entities have employed various methods to raise funds for their activities, including the sale of both stocks and bonds. However, while there are many ways to grow your money, investing in bonds is among the least risky investments that you can make. 

When it comes to stock investments, stockholders are treated as owners of the corporation. In some cases, stock investors are not entitled to receive payment or dividends from the entity. They are also not assured of when they will receive a return on their investment due to the irregular payment of dividends and fluctuating stock prices.

Bond investors, on the other hand, do not meet issues similar to those that stock investors experience. In fact, bondholders enjoy a steady flow of income because bond interests are periodically given to investors. Aside from this, bond interest rates are usually higher than those offered by banks, providing more liquidity for the investor. Most importantly, investing in bonds poses less risks than other investments because of the bond certificate’s fixed income. Investors are also more assured of their ROI because companies that go bankrupt are expected to use their liquidated assets to pay debts before fulfilling their obligations to stockholders. 

What are the risks involved when investing in bonds?

While investing in bonds serves as a relatively safer investment option for the investing public, entities gain an obligation when they sell these bonds, discouraging them from using this method to generate capital. Not a lot of people are able to do this because bonds are sold at significantly higher prices compared to stocks. For this reason, investors do not usually include bonds in their investment portfolios.

In addition to this, there are also plenty of risks that must be considered when investing in bonds. One of the main reasons why bond investment may seem unattractive is because the earnings made from these investments incur a 20% tax. Bondholders may also experience credit risk due to the possibility that the entity will be unable to pay its debtors. Additionally, economic inflations decrease the value of money, making an investor’s bond earnings less valuable.

In the context of the Philippines, it is also possible for the Central Bank of the Philippines to increase the interest rates offered by banks, making bond investments with high interest rates less valuable. Should this happen, it would be significantly more difficult for investors to sell their bonds to a second market than for a stockholder to sell their company stocks. On the other hand, if the Central Bank of the Philippines lowers the interest rate, it may be difficult for investors to reinvest their earnings. The commencement of lower interest rates affects investors with callable bonds because companies are able to pay back their principal debt at lower investment rates to relieve them of their obligation to pay. Finally, investors also incur an opportunity cost because they could have used their money to invest in stocks that generate better returns.

Indeed, investors have the safer option to buy tradeable bonds, allowing them to sell to a secondary market before the bond’s maturity date. However, callable bonds and other kinds of bonds sold by entities do not allow investors to do the same, making it vital for potential bond investors to diligently research their target corporations and organizations’ credit scores, financial statements, and other background information.

What should you consider when investing in a bond?

One other thing that potential bondholders should consider is the type of bond that he is investing in. In the Philippines, investors can put money into government and corporate retail bonds. 

Government bonds, or treasury bonds, are usually offered by the Bureau of the Treasury either by auctioning the bond or selling it to the public. On the other hand, corporate retail bonds are issued by companies publicly listed in the Philippine Stock Exchange. When comparing these two kinds of investments, it is important to consider that government bonds incur less risk because liabilities made by the government can be paid through taxpayers funds. Nevertheless, potential investors should still look into the government or company that they wish to fund to ensure that they will receive their returns.

Aside from this, bondholders should also consider the  maturity, interest rate, and face value of the bonds that they intend to purchase. The first thing to consider is the bond’s face value or par value. A bond’s face value refers to the amount for which it is sold. As such, it informs investors of the minimum amount they need to give to purchase the bond. Meanwhile, the maturity of a bond refers to the time between the bond’s issue date and end date. Finally, interest rates are percentages that represent the return of the bondholder’s investment. Usually, the longer it takes for a bond to mature, the higher the interest rates will be. 

Indeed, it is important for investors to consider both the kind of bonds that they invest in and the payment details indicated in a bond’s certificate to ensure that they are happy with the returns they will end up receiving. Using the formula below, investors can see the future value of the bonds that they invest in.

How can you get started?

In the Philippines, interested investors can either buy bonds through the Bureau of the Treasury or through secondary markets like the Philippine Dealings and Exchange Corporation. It is important to note that these two groups vary from one another. For instance, an investor can only buy bonds from the Bureau of the Treasury if it is within the offer period. On the other hand, an investor can purchase bonds outside of the offer period through secondary markets. Regardless, investors must still prepare the same basic requirements in order to buy a bond. These include a valid identification or ID card, a designated tax identification number, a minimum capital between 10,000 and 50,000 pesos, and a bank account where the interest and the principal amount can be deposited. Additionally, those who purchased tradeable bonds or bonds from the secondary market are also expected to open an account with brokers to facilitate the trading of bonds within the secondary market.

Should you invest in bonds?

It is evident now that there are many advantages and disadvantages to consider when investing in bonds. But compared to stock investments, bond investments have successfully attracted more conservative investors who wish to regularly receive a fixed income. Furthermore, this form of investment is also perfect for people who wish to grow their money without dealing with the risk of market volatility.

Indeed, bonds have proven to be one of the best kinds of investments available in the Philippine market, helping many investors begin their investment journey and diversify their financial portfolio.

 

References:

https://pesolab.com/investing-in-philippine-bonds-a-beginners-guide/ https://www.investopedia.com/financial-edge/0312/the-basics-of-bonds.aspx https://www.pinoymoneytalk.com/philippine-bonds-101/

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