Bonds - what are they and how to make money on them?
Even a novice investor can easily make money with bonds. In the article we will tell you what bonds are, what types there are, evaluate their profitability, talk about the benefits and possible risks.
In simple terms, bonds are a kind of IOUs issued by companies or issuing countries that need money. These assets are good for the investor because he knows in advance when and how much he will receive income.
The main risk of an investor is the bankruptcy of the borrower (issuer). In this case, you can lose all invested funds: unlike deposits, there is no deposit insurance here.
Types of bonds
There are various types of bonds on the stock market, let's consider them in more detail.
Depending on the issuer:
- municipal - they can be issued, for example, by city or district councils;
- commercial - they are issued by small private companies, however, such bonds are not sold freely on the stock exchange, but are offered to customers and people close to the company.
- structural and investment.
Depending on the maturities of the bonds:
- long-term - from five years;
- medium-term - from one to five years;
- short-term - repayment in less than a year.
- non-convertible - such bonds cannot be exchanged for other securities;
- convertible bonds - exchange is possible.
Depending on the collateral:
- subordinated unsecured – with high risk. When the issuer goes bankrupt, the investor only receives money if there is anything left after the distribution of all debts.
- secured - a reliable view.
Depending on the circulation of bonds:
- circulation is limited - there are restrictions, they are set by the issuer himself. For example, securities cannot be sold during the year. Or they are only available to qualified investors.
- circulation is free.
And the last type of bonds under the terms of income payments:
- Structural - with complex payment conditions. Sometimes the buyer receives even less money than he spent.
- Investment - income is not fixed, it may not be at all. However, the good thing is that the face value of the bond will be returned to you in any case.
- With an indexed par - interest income can be constant (for example, 3% of the par), and the par itself changes and depends, for example, on inflation rates.
- Discount - you can buy them below face value, and pay the full cost to the investor at the end of the term.
- Interest - the simplest terms of payment as in a deposit: the investor receives interest on the initial cost.
The issuer of structural and investment bonds is a financial institution that invests the funds received in various stock instruments. It is better for a novice investor to avoid such transactions, because these are complex financial products and their profitability is difficult to predict.
Payment of taxes
When dealing with bonds, you will have to pay taxes. However, it is worth considering:
the investor is entitled to a tax deduction if he bought bonds through IIS - an individual investment account;
the investor automatically pays income tax on income, it is calculated and removed by the issuer himself;
if the owner of the bond sells it, the income tax is withheld by the broker;
personal income tax is always deducted from income, with the exception of some points. For example, if an investor sells bonds, then personal income tax may not be paid if his earnings for the year amounted to less than three million rubles; if you bought securities on the stock exchange; if kept for more than three years.
What are the risks
The risk is inevitable. When buying bonds, you need to calculate:
Interest rate risk: An investor risks that average rates on similar securities will increase. In simple words, an investor could earn more if he chose a different type of securities.
Liquidity risk: if an investor wants to sell bonds ahead of schedule, there may not be buyers for them. This happens if the issuing company has financial difficulties or is simply unknown to the general public.
Liability restructuring risk: the issuer may change the payment term, maturity of the bonds, or the amount of interest.
Inflationary risk: when inflation rises, it can “eat up” all your income and you can even remain at a loss.
Default risk: The company may go bankrupt. But if you have secured bonds, chances are you will get your funds back.
High asset security - small and stable profits, risky assets bring high returns, but can lead to full funds. How can you find a middle ground here, multiply without succumbing to bad advice and without losing your investments?
If you do not want to risk, choose government bonds. They are not very profitable, but still your money is not afraid of inflation. Bonds of large companies can also be called reliable, they have an average yield. Ready to take a risk? Part of the money can be invested in more profitable bonds of companies that have an average credit rating of "B".