Eight Things You Should Know Before You Buy a Corporate Bond
The last few days’ events have stirred up the relatively calm level of the investment world. The pursuit of the promised returns of corporate bond hid a severe rift, and it looks like the investor may lose his money. If you are still not against this investment and want to buy corporate bonds, you should know these eight things.
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Invest or save?
To beat inflation, saving is not enough. Today, interest rates on savings products are the lowest in history. A higher appreciation of your savings can be achieved by investing – but you need to know all the risks and set the investment according to proven investment strategies.
Conservative investor versus speculator: what return to expect?
In our practice, we meet clients who claim to be very conservative from the start. That they don’t want to take a significant risk. And in the same breath, they add that they are looking for an investment with the greatest possible return. They think that investing in bonds is less risky.
When you look at the offer of corporate bonds, you will find a wide range of yields – usually from 4 to 8% pa. However, a higher result does not just fall “from the sky” – it is a reward for the higher risk you are willing to take. However, the conservative investor often ignores this fact and only looks at the yield. Ideally, when that return is announced, promised, or if you want “guaranteed”.
Drop the magic word “guaranteed” from your vocabulary. A corporate bond carries with it a declared interest, the so-called coupon, which the issuer – i.e. the company that issues the bond – undertakes to pay within the agreed terms. It is a general obligation that the company must repay the principal. Well, at least until he gets into trouble.
Ignore terms like guaranteed or guarantee. Instead, try to learn about the risks associated with investing.
Credit risk of the issuer
There is no risk like risk.
With a bond, we are mainly talking about credit risk (the possibility that the company will not be able to pay its obligations). Unlike mutual funds, you buy securities from one issuer or of one company – and so your entire investment stands and falls on the results of this company and in the event of insolvency, you take on the entire risk. If the company has problems, so will your investment.
In the case of mutual funds, it is mainly the risk of fluctuations in the unit’s price or the value of the investment account. With your money, the mutual fund manager buys securities of different issuers in the case of bonds and of other companies in the case of stocks.
Your investment is diversified, i.e. divided between dozens and hundreds of issuers and companies. Usually, no company has more than 2% in the fund’s portfolio. If one company goes bankrupt, your investment will not be jeopardized.
Who do I lend money to?
A corporate bond is your loan to a company that needs money for its investment plans. A bond is a company’s promise that after the maturity period, it will pay you the principal and, in addition, the promised income within the specified dates.
However, it is essential to know who you are lending to. As with all investments, you need to do your research.
What do I know about that company? I studied their investment intentions and what their financial condition is. What are their obligations? Or am I just blindly handing over control of my money to the seller offering me the bonds?
Certainty of return with credit risk or rather potential return with diversified risk?
If you want to invest (regularly or one-time), you should have created your diversified portfolio. Corporate bonds can also have a place in it. But only those traded on the stock exchange and, ideally, if they have an assigned rating. And they must be bought through funds that ensure diversification.
If you want to avoid credit risk, i.e., the company will not be able to return your money, mutual funds or ETF funds are one of the options. However, they do not have a declared yield and certainly not a guaranteed one. But history shows that the potential for a risk-spread return is a safer haven for your money than an inevitable return from a company that may fail.
Will you be able to sell your bonds?
Among the most significant bond issuers are companies from financial groups such as J&T, Penta, Arca Capital and Proxenta. We meet them most often. They need cheap sources of money for their investment purposes and therefore issue bonds. They create their distribution channel (for example, a bank, management company, or buy a brokerage company), through which they then move their bonds to large and small clients.
Intermediaries convinced that they have the most advantageous investment product start wholesale sales to wealthier investors and small ones who often invest their life savings. However, investing itself is not such a problem – it is worse when clients invest without knowing the principles of how bonds work, and especially their risks.
Any company can issue a bond if it meets the requirements of the NBS. However, such a bond is not always tradable on the stock exchange. Therefore, if you would like to sell it, it is practically impossible, or you will sell it at a loss.
Many companies that issue bonds are economically strong and have good investment intentions. However, in case of unexpected events, such as the corona crisis, even these otherwise strong issuers may have existential problems – and your invested money may be at risk.
Who is to blame?
Is it an issuer that has complied with the law and stated in its materials all the risks associated with investing?
An intermediary who lacks professional prudence in recommending investment products?
A client who did not read about all the investment risks before signing?
It is essential to take the primary lesson from this situation that one should understand what one invests in and invest in what one understands.
If you are going to entrust your money to an investment advisor or financial manager, look for one who follows principles, is not influenced by the company that covers him and is professionally prudent.
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