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5 golden rules for investing in bonds

The higher the rating of a bond, the better its creditworthiness and the lesser the chances of default.

5 golden rules for investing in bonds
It is imperative to have a decent understanding of the company issuing Bonds.

Having been a financial world enthusiast, it won’t be farfetched to say that the common Indian man is still not abreast with the benefits and safety associated with investing in the Bond market. This is in stark contrast to other asset classes such as equities, real estate etc. which are widely used as investment tools.

With the current wave of volatility and uncertainty gripping equity markets at home and abroad, it’s financially prudent to diversify your investments in a myriad of asset classes. The Bond market, often considered the domain of a financially savvy individual, is in reality an inherent hedge to your traditional portfolio and a great way to generate periodic income through interest payments.

That being said, all is not rosy, and as with other financial instruments, there is obviously an inherent risk involved. However, the quantum of risk involved is lesser than that of other financial assets.

Here are important points to keep in mind when investing in Bonds:

Bond Maturity should be in sync with your Investing Goal

For example, if you want to invest a lump sum amount with a specific goal in mind, like, your child’s education or a new home etc., you would have a timeline in mind e.g., 5 years or 7 years etc. Hence, the maturity of the bond should also coincide with that. If your bond matures after 7 years and you need the lump sum in 5 years, you would either need to pay an extravagant % as a withdrawal penalty or wait for 2 years, depending on the terms of the Bond you’ve invested in.

Macroeconomic Factors

Bonds are highly sensitive to inflation. They also lose value as interest rates go up.
The risk of interest rates changing before the bond’s maturity date is known as interest rate risk. These macroeconomic factors often deter a layman investor from venturing into the Bond markets. However, it is important to note that even for the most accomplished of Economists, it is borderline impossible to predict interest rate movements. Hence, instead of timing the markets, we should structure our investments in such a manner that our long-term goals are achieved.

Bond Yield and Rating

The higher the rating of the bond, the better its creditworthiness and the lesser the chances of default. The bond yield and rating are inversely proportional. This means a bond with a higher yield will have a lower rating and vice versa. Hence, an investor looking to safeguard his investments should go for higher-rated bonds (A and above) and someone willing to take risks can go for bonds rated a bit lower, and the higher returns shall compensate them for the extra risk taken.

Bond Issuer

It is imperative to have a decent understanding of the company issuing the Bonds. Its core business, market placement, standing in the Industry, Competitors and Promoter History. There have been numerous instances where investors have burnt their fingers by investing in Bonds of companies with a poor track record with more hope than data of a higher than market return.

Bond Prospectus and Broker Issuing the Bonds

No investment ever, irrespective of asset class, should be made on hearsay and herd mentality. One should carefully read the bond prospectus and understand where and how the funds are going to be allocated. Sometimes the bond name merely describes part of the allocation, For example, government bond funds can sometimes hold non-government bonds as well.

In India, where bond investing is still a niche for retailers, it is imperative to invest through a renowned platform or broker. Preferably a platform with experience in the area. It is also wise to have a thorough understanding of the fees and commissions associated with bond investments.

(By Amandeep Singh Uberoi, CIO and Founder of Grow)

Disclaimer: This is the personal view of the author.

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