What are Bonds and How Do They Work? Does it is really a Safe, Secure, and Better Investment?
Have you ever considered having a passive source of income? If so, then you might want to explore the world of bonds. Unlike Fixed Deposits (FDs), bonds offer a good way to earn a regular income and protect your capital in uncertain times. Imagine lending money to the government or a company and getting paid interest on it. That’s what bonds are all about! In this blog, you will learn about the debt market and how bonds can help you achieve your financial goals.
Bonds are a common topic in the world of finance, but do you know what they are and how they work? I know you must have heard about Bonds at some point in your life.
A bond is a type of financial instrument that is used by the Companies and Government to raise money to finance their projects and operations. Bonds are called debt instruments that represent loans made by investors to borrowers. In layman's, language a bond is generally a form of loan (Debt) that the investors pay to the borrower of Money (Issuers) for a defined time Period. In exchange for lending their money, investors receive regular interest payments and the return of their principal at maturity. Bonds help the issuer (who issue the bonds) to raise money at a lower cost between (7% to 10% p.a.) in general as compared to a traditional loan from banks, institution, etc. which is around approximately (12% to 14% p.a.). The Owners of bonds are called Debt-Holders or Creditors of the issuer/borrower.
Issuers are usually Governments or Corporations (Companies) that have big expenses or projects. For example, government may need money to develop infrastructure projects like building roads, schools, colleges, dams, hospitals, etc. Corporations may need money to buy property, and equipment, growing business, research, acquisition, or other projects. Banks or institutions are not able to lend them all the money they need or sometimes due to higher interest rates on loans, they issue bonds to many investors instead. Investors can also trade issued bonds with other investors in the secondary market (stock market) if they want to sell or buy bonds.
How Bonds Work?
Bonds have a coupon rate (interest rate) and a maturity date. The coupon rate is the amount of money that the issuer pays to the investor for lending money. When bonds are issued by any entity it can be the Government or Companies to the investors, the issuer of the bond promised in return to pay the interest amount on the invested principal amounts by the investors. The maturity date is when the issuer pays back the money that it borrowed over a specified period of time. It can be on a Yearly basis, Half-Yearly basis, Quarterly basis, or Monthly basis as promised by the issuer of the bond. Bonds are considered to be a relatively safe investment compared to other higher risky investments such as (Shares, Real Estate, Private Equity, and Crypto-Currency).
How to Choose the Right Bond?
The right bond for you will depend on your individual needs and goals. If you are looking for a safe investment with a steady stream of income, then a government bond may be a good option. If you are looking for an investment that has the potential to grow in value, then a corporate bond or a high-yield bond may be a better choice.
Your investment goals: What are you hoping to achieve with your investment? Are you looking for a steady stream of income? Are you trying to grow your money over time?
Your risk tolerance: How much risk are you comfortable taking with your investment? Bonds are generally considered to be a safe investment, but there is still some risk involved.
Your time horizon: How long do you need to keep the investment? If you need to access your money in the near future, you may want to choose a bond with a shorter term.
Your tax situation: Consider the tax implications of investing in bonds. There are so many bonds available in the market which is tax-free such as SGVs (Sovereign Gold Bonds) are free from tax whatever you have earned in the capital gains arising at the time of redemption (after 8 years) are tax-free.
That’s it for this blog, in the next blog will talk about Benefits and risks.
Still, do you have any questions about bonds? And is this blog useful for you? Share your thoughts in the comments section below! I would love to hear your feedback on this blog post and don’t forget to hit the like button if you like the information provided in this blog. See you soon in the next part of the Bonds series Part-2.