The great economist John Kenneth Galbraith was fascinated by the fact that in markets, there is always a buyer for every seller. That may be easier to understand when stock prices rise, but what is puzzling is when they plummet. Even when their value is negative, as happened when investing in bonds for many years.
Not only can that aspect be fascinating or enigmatic, as Galbraith explained, but it also speaks very well of the markets. Especially bond markets, since it could be said that they always emerge unscathed and strengthened, even in the worst situations. And they are getting stronger, as billions more of them are in circulation every year. But that is really their function: to be a reliable instrument for investors, especially when there are problems.
What are bonds?
Bonds, also known as fixed income instruments, are debt issued by governments and/or companies to raise money, with the objective of dedicating those resources to specific projects. In exchange, the issuer of the bond commits to repay the investment with interest over a given period of time.
Behind these instruments there is a huge market of trillions of euros and numerous players. On the one hand, there are the issuers, which can be companies, municipalities, governments or international entities. On the other hand, there are the buyers, ranging from small investors to large funds. Finally, there are other players in between, such as the rating agencies that supervise the quality of the bonds or international criminal courts set up to settle default proceedings.
Types of bonds
The market for investing in bonds is huge and can be divided in many ways. The most important are:
- By origin: here we differentiate between state (governments), corporate (companies), municipal, etc.
- By rating: investment grade (higher rating) and high yield (lower rating).
- By duration: they can be short term, in which case they are bills (usually from governments), medium term, in which case they are bonds, or very long term, which are debentures or perpetual bonds.
- By the project it finances: a new classification that has gained much relevance is to divide bonds by the projects they finance, so we have green or social bonds, among others.
How do the bonds work?
Bonds work as flow generators, which means that owning them allows you to receive a recurring payment. So when the issuer brings the bonds to market, it does so with a commitment to investors that it will pay back that money along with interest, which is the part you receive each month. That interest is known as a ‘coupon’ (a word that comes from the days when physical coupons were attached to bond certificates) and represents a percentage of the amount paid for them.
More technically, that interest paid by the coupon is known as the coupon interest rate or the nominal yield (NR). So, if you are going to invest 10,000 euros in bonds and their coupon is 10%, you will receive 1,000 euros per year. Finally, keep in mind that payments are usually made semi-annually or annually and that there is a special payment, on the maturity date, in which your initial capital is returned to you.
Advantages of investing in bonds
Investing in bonds has a number of important advantages.
- Preservation of capital: bonds represent a protection of the absolute value of the investment, as they have less risk than stocks.
- Income generation: as we have seen, bonds provide a fixed amount of income at regular intervals in the form of coupon payments.
- Diversification: investing in bonds helps to have a more diversified portfolio. First, because they tend to move in the opposite direction to stocks, i.e., it balances our investments. Secondly, because it is a very safe asset. Finally, because it is a safe haven of security when things go wrong or there is high inflation.
- Risk management: Fixed income is generally understood to carry less risk than equities. This is because fixed income assets tend to be less sensitive to macroeconomic risks, such as economic downturns and geopolitical events, and sometimes even benefit from them by raising the interest they pay.
Investing in bonds through roboadvisors
If you want to invest in bonds, roboadvisors are a good choice. In short, a roboadvisor is an automated manager that creates investment portfolios based on the financial profile (and risk profile) of each user with the help of algorithms. The great advantage of this automation is, for example, that you can access a service at a very low cost that was previously only reserved for high net worth individuals.
But this is not the only benefit; there are many more. Another advantage is that, by creating portfolios, in this case of bonds, we create a diversified portfolio, since this is one of the bases on which the algorithms are built. On the other hand, they do not require high minimum amounts and are intuitive and easy to use platforms, which makes them reliable. The sum of all these characteristics has allowed the use of roboadvisors to grow exponentially.
Investing in bonds with inbestMe
inbestMe is a good choice for investing in bonds. The platform has a wide range of products, including green bonds and corporate bonds, and experience in Spain, along with a broad offering of fixed income products, which will allow you to create a portfolio tailored to your profile and risk. And at very competitive prices.
As for the process, it is also very simple. Firstly, you must access its fixed income section where you can find two different types of portfolios: one focused on preserving capital, called Conservative, and another that seeks to maximize profitability, called Aggressive. In both cases, the minimum amount to invest is 5,000 euros and both are prepared to offer a high diversification and to be configured to be as tax efficient as possible.
