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This piece has been expert reviewed and fact checked by Forbes Advisor Australia Board Member, Shani Jayamanne, award-winning senior investment specialist at Morningstar, who is also the co-host of Morningstar Australia’s Investing Compass podcast.
Learning how to buy bonds is an essential part of your education as an investor. A well-diversified investment portfolio should strike a balance between equities and fixed income, letting you ride out volatility while capturing growth along the way. Let’s take a closer look at the basics of buying bonds.
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Why Invest In Bonds?
Bonds tend to offer a reliable cash flow, which makes them a good investment option for income investors. A well-diversified bond portfolio can provide predictable returns, typically with less volatility than equities and a better yield than money market funds.
Take the recent performance of bonds versus stocks, as an example. The Australian share market hit a six-month low in the first week of October this year, prompted by fears that interest rates will have to stay higher for much longer. The good news for investors in bonds is that global yields have surged in recent weeks, which has had a positive impact on the bond market in Australia. While yields are likely to fall when central banks start cutting rates, this is not expected to happen until late 2024.
The Australian Government has never defaulted on the interest or repayment of the principal payments on the bonds, which is why so many investors consider bonds to be a ‘safe pair of hands’.
Even when interest rates are low, bonds are still preferred by many investors because of the relative stability they offer compared with, for example, stocks — let alone the highs and lows of cryptocurrency.
“The purpose of fixed-income investments is to add diversification to a portfolio,” says Rich Powers, Head of ETF Product Management at Vanguard.
In fact, it’s not uncommon for default superannuation accounts of Australians to be exposed to bonds, owing to their high degree of stability.
Australian Bonds Explained
When you invest in bonds, you are lending money in return for regular payments, known as coupon interest payments. All bonds have an agreed or face value, when they are issued and, as Moneysmart explains “ If you hold the bond until maturity, you get back the face value (or principal) of the bond.”
If you sell a bond before maturity, you’ll get the market value, which could be lower or higher than the face value.
Broadly speaking, there are two types of bonds: corporate and government bonds. Let’s start with the riskier of the two: corporate bonds.
Corporate bonds
Corporate bonds are primarily issued and traded on the over-the-counter (OTC) market and they are a way for large companies to raise money to finance their projects. As the minimum investment rate is typically in the hundreds of thousands of dollars, it is unusual for the mum-and-dad investor to buy into corporate bonds.
Government bonds
The standard Australian government bond (AGB) guarantees a rate of return on the bond’s value when held to maturity, while semi bonds can only be bought and sold through state and territory treasury corporations.
Investors who are after a regular return on their bonds, often opt for Exchanged-Traded Treasury Bonds (eTBs). There are two ways you can invest on the ASX in this way: through the standard (eTBs) or via Treasury Indexed Bonds (eTIBs).
So what’s the difference between the two?
With Exchange-traded Treasury Bonds (eTBs) you receive coupon interest payments, usually every six months, and can buy or trade the bonds anytime the ASX is open. These securities provide ownership of bonds via CHESS Depositary Interests (CDIs) and carry a fixed annual rate of interest. The loan is repaid to the investor once the bond matures.
Exchange-traded Treasury Indexed Bonds (eTIBs), on the other hand, are indexed to the consumer price index, which means the coupon payments are adjusted in line with inflation. The payments are usually made every three months instead of twice a year.
How to Buy Individual Bonds
There are a number of ways the average investor can gain exposure to the bond market, and we have outlined some of the most popular paths below:
Through a broker: If you want to buy bonds that are not publicly traded then you will likely have to engage the services of a broker. As most corporate bonds require a huge investment, brokers can help you access this market and buy the bonds directly from the company issuing the bonds.
Through managed funds: A managed fund is a great way to gain exposure to the bond market, and what attracts many investors to this avenue is that the managed fund is, as the name suggests, managed. It’s a much more active form of investment, but the fees are likely to be higher too.
Through an ETF: If you don’t have the money to invest in a corporate bond, and many retail investors don’t, then many will access the bond market though ETFs, which track specific types of bonds, such as Government bonds, American high-yield bonds, or even long-dated Australian government bonds.
Risk of Buying Bonds
Government Bonds: Of course, while government bonds are considered one of the safer investments, no investment is entirely risk-free. The Australian Government notes that one of the risk of investing on non-indexed Treasury Bonds is that if inflation rises, generally speaking, the value of the bond would fall. Furthermore, it points out that Government may at any time “subject to a minimum period of three months’ notice”, convert holdings of eTBs to the underlying Treasury Bonds directly registered in the Commonwealth Stock Registry. In this case, investors would still receive the same coupon payments, but would not be able to sell their investment on the (ASX).
Corporate Bonds: Moneysmart warns consumers that scams are common in the corporate bond market, so make sure you do your due diligence first.
Moneysmart, for example, recommends:
- Checking if the prospectus is lodged on ASIC’s offer notice board? “If not, it is likely a scam,” the site warns.
- Ensuring the offer or prospectus is from a legitimate source. “If you’re not sure, go to the issuer’s website to download the prospectus and application form (with bank account details).”
- Making sure the bond is actually available to you. “Some bonds, such as green bonds are not available unless purchased in a managed fund. Be cautious if someone offers you these types of investments.”
Most important of all is the need to be aware of the risk of investing in a corporate entity that may go under and will be therefore unable to pay your coupon payments. It is one of the chief reasons that corporate bonds are considered riskier than government bonds, and, why the interest rate is higher to account for this risk.
The Bottom Line
Buying bonds, whether individual bonds or as ETFs, provides diversification and reliable income for your investment portfolio. With all bond-related investments, you must do your due diligence: Research issuers, and if possible, consult with your investment professional to help guide your choices.
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Frequently Asked Questions (FAQs)
Do you pay tax on bonds in Australia?
Yes. Any income that has been derived from interest or capital gains will be subject to tax. Australians pay tax on their investment income at their marginal tax rate. As Moneysmart notes, earnings in an investment bond, which are structured differently to standard bonds, are taxed at the corporate tax rate of 30%, so can be tax effective for those on higher tax rates. See your accountant for more details on paying tax on bonds.
Are Australian bonds a good investment?
They are certainly a safer investment than many other assets classes, such as commodities or even corporate bonds. This is because the Australian government has never failed to pay investors coupon payments or the principal upon maturity, and so are considered extremely safe. As a result the interest rate of return is lower than corporate bonds, so would they may not suit an investor craving a higher level of exposure to risk.
What is the 10-year bond rate in Australia?
As of October 6, the 10-year bond rate in Australia is 4.558%, retreating slightly from its 12-year high of 4.6%.
What is the minimum amount I can invest in Bonds?
The minimum amount required to invest in either Exchanged-Traded Treasury Bonds (eTBs) or Exchange-Traded Treasury Indexed Bonds (eTIBs) is $100 or one unit, face value.