In today’s ever-changing financial environment, investors must consider a number of key factors when deciding which bonds to invest in.
Bonds, issued by both governments and corporations, offer an investment alternative with a generally low risk profile. However, the safety and yield of these assets depend on several elements, such as the issuer, the type of bond and its sensitivity to market fluctuations, among others.
The following article will explain the main types of bonds available for investment, analyzing their characteristics and performance.
What bonds to invest in: Types and key features to choose safely
The dynamics of bonds may not be entirely clear to many investors, especially in the case of corporate or private bonds. Unlike government bonds, these tend to have more complex structures and terms, which can lead to some uncertainty.
For this reason, it is crucial to understand how they work before deciding which bonds to invest in, as each type has its own risks and rewards. The main private and government bonds to invest in are as follows:
- Government bonds: These bonds, issued by the Treasury or the national government, have terms ranging from two to five years, with a range of three to five years being common in Spain. They are considered one of the safest investments because a default would imply a national default, which would lead to a severe economic crisis.
When compared to other investment alternatives, they are attractive because of their stability. They offer periodic interest payments, which can be quarterly, semi-annual, or annual, while the principal is repaid at maturity. For those wondering which bonds to invest in, government bonds represent a solid and reliable option.
- Corporate bonds: They are an attractive investment option for investors wishing to diversify their portfolio beyond stocks. These bonds, issued by companies, are used to finance projects, expansions or refinance debt.
Unlike government bonds, they offer higher yields due to the higher risk associated with the issuing company’s credit. This higher yield may be attractive to investors willing to take on more risk in search of higher returns.
- Perpetual bonds: These are a type of investment instrument that has no maturity date. This means that the issuer pays interest to the investor indefinitely and is not obligated to repay the initial principal. They are considered a form of long-term investment that offers continuous periodic income.
- Convertible bonds: Also known as hybrid financial instruments, they combine debt and equity features. They allow investors to convert these bonds into shares of the issuing company under certain pre-established conditions.
For those wondering which bonds to invest in, convertible bonds provide the opportunity to benefit from the growth potential of the issuing company. In addition, unlike a direct investment in stocks, convertible bonds provide inherent protection against share price depreciation, as they continue to pay interest and have priority over shares in the event of liquidation.
- Zero coupon bonds: These are bonds that do not pay periodic interest. Instead, they are sold at a price below their face value and the return is obtained when the full value is repaid at maturity.
For example, imagine that you buy a zero coupon bond for 800 euros, and its face value is 1,000 euros. At maturity, you will receive 1,000 euros, which means that your return is the difference between the purchase price and the face value.
- Floating rate bonds: They adjust their interest rate over time based on benchmark indexes, such as LIBOR or the short-term Treasury bill rate. This adjustment has an impact on the interest payment, which may increase or decrease according to market fluctuations.
They offer protection against inflation and rising interest rate risk. As market interest rates rise, the interest rate on these bonds also adjusts, which can lead to higher interest payments for the investor.
- Subordinated bonds: If you do not know which bonds to invest in, you may want to consider subordinated bonds. These bonds have a lower priority of payment in the event of bankruptcy or liquidation of the issuing company, meaning they are paid after other debts and obligations.
However, this additional risk is offset by a potentially higher yield compared to ordinary bonds. That is, due to the greater uncertainty and risk associated with their position in the payment hierarchy, issuers compensate investors with more attractive interest rates.
Main factors to consider when selecting which bonds to invest in
Now that you have an expanded view of the wide variety of bonds currently available, it is important to analyze the factors you should consider when selecting which bonds to invest in. The main ones are as follows:
- Bond duration: The longer the duration, the more sensitive it will be to market fluctuations. Therefore, it is crucial to evaluate whether the bond duration is suitable for your investment profile. Depending on the economic environment and your specific goals, you can decide whether a bond with a longer or shorter duration better suits your needs.
- Yield or return on investment: Before choosing, compare the return on investment between the different bonds available. This return can be analyzed by considering the interest rate or percentage yield and may vary according to the type of bond, the credit quality of the issuer and market conditions.
- Credit rating of the issuer:Research the company issuing the bond, how it operates and its ability to meet its obligations. This will give you insight into their financial strength and the risk associated with the bond.
- Current economic situation: Understanding the current economic context of the market is key. Depending on the financial conditions, you will be able to make a confident decision. For example, in times of economic uncertainty, it is preferable to opt for government bonds, while when there is economic growth, corporate bonds are more profitable.
- Inflation outlook: Inflation has a direct impact on bond yields. In inflationary environments, bonds with fixed interest rates may lose real value, as periodic interest payments are not adjusted to changes in the general price level. In such conditions, it may be more appropriate to consider bonds with variable interest rates or instruments designed to be inflation-protected, such as bonds indexed to price indexes.
- Current monetary policy: Another factor to analyze is the monetary policy in place at central banks, as this has a direct impact on bond yields. For example, in periods of low rates, it is more profitable to invest in bonds with fixed rates in the long term; however, if there are projections of rising rates, floating rate bonds may be a better option.
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