No, no. Not James Bond silly. C’mon now….
I’m talking about the financial term bond, and why you should have these types of investments in your registered and/or non-registered accounts.
WHAT IS A BOND and how do they work?
- When you buy a bond, you are basically turning yourself into a bank. You loan your hard earned cash to the government, a city/province, or a company for a set period of time at a variable or fixed interest rate. The interest rate that goes along with a bond is often referred to as the bond’s yield.
- The set time varies from under a year to as long as 30 years. When a bond hits its maturity date, the bond issuer is meant to pay back the full amount of your original investment. Government and/or corporate entities will often issue bonds in order to fund a new project, or to assist with the massive amounts of debt that they could be in.
Let’s say a local school on the tropical island of Labombom needs money to build a new bridge but they just can’t find the funds. They issue a 5-year bond at a fixed interest rate of 5%/year. You invest $1000 in 2010. Every year until 2015, they pay you $50 as interest (5% of $1000 = $50). When the bond’s maturity date has arrived, the school pays you back your initial loan amount of $1000. This means that over the 5 years, you would have made $250.
WHY YOU SHOULD HAVE BONDS IN YOUR INVESTMENT PORTFOLIO
- Bonds are a reasonably safe investment and will often outperform stocks and mutual funds if the stock market crashes. Think of them as your safety net!
- Bonds give you regular pre-scheduled payments on a quarterly, bi-annual, or annual basis. Yay for supplementary income.
- Interest rates on bonds are often higher than savings accounts at a bank.
- If the government or corporation fails to pay the promised payment, you’ll be the first to receive money if any assets are sold. If you hold stocks, you’re the last person to receive money.
THE CONS OF BONDS
- With relatively low-interest rates, bonds don’t produce as much of a return as mutual funds or stocks could.
- Any income made from bonds are taxable unless they’re sheltered in a registered account (TFSA, RRSP, RESP or RRIF).
- A government or corporation can fail to pay the promised amount. There’s really no 100% safe investment, although bonds are probably one of the safest.
Well – there you have it. A quick and dirty overview of what bonds are. I hold them in my personal financial portfolio as a safety net in case the market takes a tanking. If you need to talk this through a little more, please contact me! I can help you!