Bonds are considered a safe form of investment. But what is that anyway? How do they work? We’ll explain it to you – and show you whether, when and how you should invest your money in bonds.
At Bonds or bonds are about one creditthat a state, but also a company, accepts and issues a promissory note for it. This promissory note including a fixed interest rate and a fixed term is called a bond.
What many do not know: As an investor, you can invest in these promissory notes. But what exactly are bonds? Is it really safe to invest in bonds? And what should I consider when making an investment? t-online gives an overview.
How exactly do bonds work?
The central element of a bond is already in its name: “borrow”. Anyone who issues a bond wants to borrow money and offers one in return for the loan Promissory note with a fixed term and interest.
If, for example, a state issues a bond, funds, insurance companies, banks, but also small investors and investors can buy this security. In this way, they borrow money from the state for a period of time – the term of the bonds.
As if they were a bank, the lenders get paid interest on the loaned money during the term, too Interest coupon or coupon only called. In technical jargon, bonds are therefore also called fixed income securities or Bonds.
At the end of the term, the lender receives his money back. Typical terms for government bonds are 5, 10, 20 or even 50 years. The maturities of corporate bonds are usually shorter.
Good to know: Countries and companies that issue bonds are also called issuers.
How can I make money from bonds?
To get financial income from bonds, you can use the promissory notes on the one hand buy, hold and collect interest for the duration of the term. In this case he plays Face value a bond plays a crucial role.
The face value or nominal amount of a bond is the amount of money that the issuer of a bond owes the lender and must repay at the end of the term. At the same time, the nominal value determines the size of the parts of the total bond volume. So if a bond has a face value of € 1,000 but you want to invest € 4,000, you have to buy four bonds with a face value of € 1,000.
On the other hand – and this is the more common form – you can also invest in bonds during the term. Because bonds are traded on the stock exchange. In this case you do not need to wait until the end of the term.
Instead, you buy a bond at any point in time called the Market value. After a while you sell them again – in the best case at a higher market value, so that you make a profit.
The market value indicates how the nominal value changes during the term due to demand on the stock exchange. At the beginning, i.e. when a bond is issued, the market value is 100 percent of the nominal value. In between it fluctuates – so it can be significantly above or below the original value. Towards the end of the term, the market value usually approaches the nominal value again.
How safe are bonds?
Basically: It depends on the Creditworthiness of the state or company from. Because the risk increases, the greater the chance that a state or a company will not repay the borrowed money, i.e. the loan will fail.
The creditworthiness is regularly checked by so-called rating agencies. Companies and states that have little debt receive a good grade.
The best possible grade is “AAA”, known as “Triple-A”, the worst possible a “D”. There are also different levels, including plus and minus like in school. Experts strongly advise against investing in bonds from companies or states with a rating of “BB +” or lower. Because these are considered very speculative.
The risk of bonds also depends on the currency in which the bond was issued. This is also called Currency risk. You should be aware that a currency can fluctuate widely, which can have a negative impact on your returns.
How do I invest in bonds?
The easiest way to do this is via so-called Pension funds invest in bonds. This is basically a basket of investment funds that are used to buy and sell various bonds at market value (see above).
Another variant are so-called Bond ETFs. With these, a computer algorithm simulates a bond index, which shows the performance of the bonds in the index. With a bond ETF, you invest in all of these securities.
Are bonds still worth it?
Bonds are considered a very safe form of investment because their prices are less volatile than stocks, for example, generate a fixed interest rate, the coupon, and are redeemed at the end of the term.
At the moment, however, they are hardly generating any income due to the low interest rates (see below). However, experts advise – precisely because of the low risk – to add bonds to the Portfolio to give.
What does the bond yield consist of?
The yield on bonds called rate of return, usually does not only depend on the interest you get paid. Because: Most of the time, you don’t buy a bond at exactly its face value (see above) and then buy it on End of term to sell again.
Instead, you can also invest in bonds during the term – and sell them before the end of the term. Then buy a bond for the so-called Market value (see above). The return therefore depends on the following criteria:
- Stock market price: The price of a bond determines the return. It depends on investor demand. However, this changes if the market interest rate rises or falls (see below).
- running time: The longer a bond runs, the higher the yield tends to be.
- Purchasing power: If a company or a state is very solvent, i.e. has a high credit rating, this has a negative effect on the return – because the lower the risk, the lower the income.
Market interest rate and bond price
Investing in bonds seems a bit complicated at first. To blame Price logic of bondswhich at first glance seems paradoxical. Because the bond demand from investors – and thus the Bond rate – is from the so-called Market interest rate influences, i.e. the level of interest that banks offer.
The Paradox for bonds:
When market interest rates rise, the price of a bond usually falls. The reason: when interest rates rise in the market, the interest rates on newly issued bonds also go up. Investors would then prefer to invest their money in new bonds with the higher interest rate – and not in older bonds that were issued earlier and with a lower interest rate. The reverse applies according to the same logic: If the market interest rate falls, the stock market price of a bond rises.
When should I invest in bonds?
You should borrow from falling interest rates to buy. What sounds paradoxical at first, follows the price logic of bonds (see above): When interest rates drop at banks, many investors try to get better interest rates – and buy older bonds from companies or states because they promise higher interest income than the bank . The result: bond yields increase.
If the Interest rates rise, the phenomenon is reversed: Because the bank gives more interest, companies or states must also promise more interest on their new bonds. At such a moment, investors sell comparatively “old” bonds with lower interest rates in order to secure the new ones with higher interest rates.
Right now that is Market interest rate very low. The reason: The key interest rate of the European Central Bank has been at zero for years. And interest rates in other countries are also currently low. Therefore, if you do not hold any shares in bonds, you should wait until rates have risen again.
What types of bonds are there?
In addition to the differentiation according to the respective issuer, i.e. government and corporate bonds, there are other types of bonds. An overview:
- High yield bonds: These are basically a very risky form of corporate or government bonds. Because: The issuer’s purchasing power is very low. A state or a company must therefore pay investors high interest
- Bonds: This is a special variant of corporate bonds. Certain security features are stipulated here – but the return on investment suffers.
- Convertible bonds: This is a special form of bond. Because these bonds can be “converted” into stocks – hence the name. However, they are not suitable for private investors.
- Federal Treasury Bills: These types of bonds are no longer on the market. They were issued by the federal government between 1969 and 2012 and were known as safe, fixed income securities. The state borrowed money directly from its citizens in this way. Very small sums of money could already be invested in federal treasury bonds, which is why they were particularly popular with private investors.