What are saving bonds, how do they work and how to invest in them
Bonds are a type of financial product that you have surely heard about more than once, but do you know exactly what saving bonds are? What types are there or how to invest in them?
We are going to see everything you need to know about these fixed income products so that at the end of this article you can know if the bonds are for you or not.
What are bonuses and how do they work?
A bond, also called debt security, is the proportional part of a debt issued by a public entity, the State, or a private company in such a way that it raises funds to finance itself.
A simple way to look at it is that investors play a role similar to that of the bank, lending money in order to collect interest and get their investment back at the end of the term (in the case of some types of bonds). Therefore, the investor also becomes a creditor.
Bonds are a fixed-income asset for which we know in advance what the return on investment is, that is, we know the return on investment at the end of the term, as well as the type of interest that we will have.
Of course, this does not mean that the bonds are guaranteed instruments, nor an investment without risk, as we will see later.
Types of bonds
There are different types of bonuses depending on their characteristics, but we will start by distinguishing the two large groups:
1. Bonds issued by the state or institutions: Type of investment based on the debt system, by which money is lent to a government in exchange for an interest rate that has been agreed upon. They are usually saving bonds than those issued by companies, but also with a lower return. An example of a government bond:
You invest 10,000 euros in a 10-year government bond with an annual coupon (yield) of 4%. This implies that each year the State will pay you 4% of your 10,000 euros as interest and, when the determined maturity period ends, it will return your initial investment.
2. Bonds issued by companies: They tend to offer more profitability than government bonds, along with less security. This return will be higher or lower depending on the strength and growth of the company that issues these bonds.
Jeremy JW Cunningham, Fixed Income Investment Director of Capital Group, told us about the investment opportunities they see from the manager in corporate bonds.
Other types of bonuses:
- Exchangeable bonds: They can be exchanged for existing shares of the company.
- Convertible bonds: They can be exchanged for newly issued shares with a lower return.
- Zero-coupon bonds: No interest is paid month by month, but the accumulated interest is paid at the time of maturity.
- Perpetual debt bonds: They never expire, so the invested capital does not return. However, they earn interest in perpetuity.
- Cash Bonds: Issued by companies to meet cash needs. Yes, the invested capital is returned.
- Strip bonds: Separates the value of the bond in each of the payments it generates, in such a way that it allows the interest money and the capital money to be negotiated separately.
- Social bonds: Its objective is to finance projects with the aim of mitigating a specific social problem.
- Green bonds: Intended for the financing or refinancing of ecological projects. Precisely this September, Spain issued its first green bond: 20-year debt for environmental projects. The Executive has identified more than 13,600 million euros of eligible green spending.
- Bonds linked to sustainability: linked to the achievement or improvement of certain environmental, social, and/or corporate governance metrics.
- Inflation-Linked Bonds – Bonds whose yields depend on the level of inflation in the future. They offer us the same as traditional bonds, with the advantage that they protect the value of our savings.
- Junk bonds: These are high-risk, low-rated bonds that generally reward risk with high yields. Also known as High Yield bonds, they have a credit rating that entails investment risk due to the high probability of default by the issuer.
How to buy bonds
Buy bonds in the primary market
The primary market is one in which the sale of bonds is carried out through auctions. In this market, the main buyers are banks and institutional investors, as well as some private investors.
Buying bonds in the secondary market
The secondary market would be the market in which the bonds that were acquired in the primary are sold, facilitating access to them for private investors through a broker.