Investing in bonds: a safe haven for investors?

Investing in bond is considered as perhaps the  safer part in any portfolio like a port in the storm. No matter what name it may be called, it will always be  considered as a ‘safe haven’ for those people who prefer capital protection and require regular and predictable income streams.

How do bonds work?

When you buy a bond, you’re lending your money to the issuer of the bond – be it  a company or the government ( or the bond issuer) for a set period of time (or the term). The term can be anywhere from a year or less to as long as 20 years.  Once you invest in the bond , the issuer pays you interest. When  the bond becomes due (or maturity date), the issuer is supposed to pay back the face value or maturity amount  of the bond to you in full.

How do you earn money from bonds? 

 Interest payments: In most of the bonds, you will get regular interest payments when you hold the bond until maturity and they are typically paid a fixed or a floating rate of interest.

Fixed interest rates do not  change through the entire term of the bond. Some have floating rates that go up or down over time based on the prevailing market rates. On the bond’s maturity date, you will get back the face value or maturity amount.

How can I invest in bonds ? What is the process?

Bonds can be issued by PSUs, governments, as well as corporate organisation, in order to raise capital.

Process of investing in bonds is simple as investing in any other instrument. Whenever a company is issuing bonds,  all you have to do is to fill the application form and submit it to any branch of the issuing company with the application fee and required documents. 

These documents may include soft copy of PAN Card, address proof, bank account proof, etc. If you have Demat account, the bonds will get credit in this  account. In case you do not have one,, then you can choose to receive the bonds as  physical bonds  or certificates.

Government bonds are sold through official distributors and designated branches of banks .

Bonds are subject to credit risk–  very important: Investors should note that bonds are subject to credit risk i.e (bond default risk). This is the risk whereby an investor may lose part or all of the investment because of issuer’s insolvency, or inability to pay the interest and / or  principal.

The greater the credit risk, the more interest the issuer has to pay to sell its bonds and higher the possibility of default of interest and / or principal. Bonds are therefore rated based on their credit risk. Credit ratings may differ for different issues of bonds and even by the issuer. Generally, bonds which have the highest credit ratings, are secured by assets.

Some of the top rating agencies in India are: CRISIL, ICRA, CARE, Fitch rating and Brickwork rating.

Here are some of the rating nomenclatures used by the rating agencies to rate bonds: AAA: Highest safety, AA: High Safety, A: Adequate Safety, BBB: Moderate safety, B: High Risk, C: Substantial Risk, D: Default. Some examples of bonds are Government of India bonds, corporate bonds, tax saving bonds, tax free bonds, zero coupon bonds and junk bonds, among others.

Investing in bonds — in the current environment: Since conservative investors have a low risk tolerance level and they do not like to grapple with volatility in equity markets, they should have a higher  allocation to bonds in their portfolios  to achieve not just good but stable returns.  

A retired person  wanting guaranteed regular monthly pension should have a higher allocation to bond investments than a much younger person who is at the peak of his career.

Therefore, based on your risk profile , your financial goals, and phase in life, you can allocate investments into bonds.

(The writer is Managing Director at Sinhasi Consultants)