Bonds are one of the most attractive investment assets and are a great source of passive income. A lot of investors have bonds as part of their portfolio, this is because bonds are safe and produce reliable income. This is a guide on how to invest in bonds in South Africa.
What are bonds?
A bond is a way for governments or corporates to raise money through the public. They do this by offering bonds, a bond allows investors to lend money to a government or a company. In this case you are not buying equity but loaning out money to these entities.
The loan is paid back to an investor with interest. These entities issue bonds for fundraising purposes, the government raises funds for infrastructure development. Corporates issue bonds to raise funding for their projects or operating expenses.
An investor buys a bond for a certain period of time, usually anywhere from 1 year to 20 years. The good thing about bonds is that you don’t earn your interest at the end of the investment period but you earn it semi-annually. This means that you will receive an interest pay-out every 6 months.
Why do investors buy bonds?
The main reason why investors buy bonds is because bonds are much safer than other investment assets. The government is not likely to default on its loan and a company still has to honour its bonds even when bankrupt.
Bonds are also very predictable, the income that you earn from bonds is predictable because interest rates are usually fixed. Other investment assets are more volatile and unpredictable. A bond can serve as a reliable source of income in time of financial distress.
Government bonds are safer than corporate bonds but generally have lower yields in interest. A government issues out a bond when it wants to fundraise, this is because as much as we might think the government has all the money, they sometimes run low on cash.
This happens when they didn’t collect the amount of tax they had projected to collect, which is caused by a number of things. They issue out bonds to compensate for the amount that was not collected. When you buy government bonds; you are lending your money to the government.
The most famous bond in South Africa is the RSA Retail Savings Bond. It requires a minimum of R1 000 to buy but may not go for over R5million. The investment period for Retail Savings Bond is between 2 and 10 years.
The Retail Savings Bond comes with 2 investment options. You can either invest in a fixed retail savings bond or an inflation linked retail savings bond. Fixed Retail Savings Bond generally have greater interest but are vulnerable to inflation.
Inflation Linked Retail Savings Bond have lesser interest but protect you from inflation. The interest rate is fixed but it is always adjusted for inflation. A lot of smart investors go with inflation linked savings bond.
Corporate bonds have greater interest compared to government bonds. It’s easier for a company to give out bonds than to sell equity. Selling equity requires the company to give up a percentage of ownership. Bonds allow the company to raise the money they need without losing part of their ownership.
Investors buy corporate bonds because of the greater interest that you receive from these bonds. Not all corporate bonds are created equal since they are issued by individual companies. Some companies are at a greater risk of defaulting than others. There are rating agencies that make it easy for you to evaluate the creditworthiness of a corporate entity.
Investors generally hold on to bonds until they mature, upon maturity, you receive your principal amount in full. If you had initially invested R100 000 then you will get R100 000 when your bond matures, this comes after you have been getting interest payments every six months.
You may decide to sell your bond before it reaches maturity. This can be due to a number of reasons; you may be in a financial crisis and pressed for cash. You can sell your bond to other investors but likely at a lower price. This usually happens after you have received a few payments of interest.
Where to buy bonds?
This was a guide on how to invest in bonds in South Africa. Do you have any thoughts or questions?