The bonds market has grown in size as time passes; more and more people decide to invest in bonds. When you’re considering investing in bonds as a whole, you should learn as much as you can about it. In this article, we’ll discuss fixed rate bonds: what they are and how to find the best one for you.
What are Fixed Rate Bonds?
Fixed rate bonds are a type of bond with fixed coupon (interest) rates for the duration of the bond. They pay the same amount of interest for the entirety of its term. If you wish to guarantee the interest rate for a certain amount of time, you could buy a fixed rate Treasury bond, corporate bond, or municipal bond.
You can see the fixed rate in the trust indenture at the time of issuance. The payments can then be made on specific dates until the bond reaches maturity.
One of the benefits you can reap by investing in fixed rate bonds is certainty. You can make sure of for how long and how much interest you’ll earn. It can be easy for you to predict the exact amount of return on investment you’ll receive. This is something you can do as long as the bond issuer does not decide to default or call in the bonds.
On the other hand, one of the key risks of owning fixed rate bonds is the interest rate risk. There is a chance that bond interest rates will climb. With that, there’s a possibility that your existing bonds will be less valuable.
Finding the Best Fixed Rate Bonds
There are some factors you should consider when finding the best fixed rate bonds that will suit you. Keep in mind that there are different accounts considered as the right one for different types of people. Here are some questions you should answer when determining the best fixed rate bond for you.
What is the interest rate?
Despite seeming pretty obvious, you should remember that there some accounts which have tiered interest rates. This will actually depend on the amount you have in your account. Therefore, you must make sure that you know the rate intended for your balance.
When does the fixed rate end?
It’s imperative for you to do this. You should always find out when the end of the fixed rate will be exactly. Once you have this information, you should take note of the date and remember it clearly. This will lead you to the next question.
What rate does the fixed rate revert to?
Once you’re able to establish when the fixed rate will end, there are some changes you could anticipate. The end of a fixed rate period will probably signify the reversion of the bond to a lower rate. You should at least make sure that you compare the different accounts. Consider switching to the account with the best rate you can find once it reverts to a lower rate.
Is it possible to make withdrawals? Are there any withdrawal penalties?
It’s also important for you to find out if you can make withdrawals. If the answer is yes, you should also learn the withdrawal penalties and the impact they’ll have on your savings.
What is the minimum investment?
There are numerous fixed rate savings bonds that require you to invest a huge sum deposit. You need to find out the minimum amount of investment before submitting your application.
When is the interest paid?
You should find out what time periods will you be able to receive the interest you earn. Will you receive it monthly? Will you receive it annually? You also have to be aware of when the bond will mature.
Is it possible to make regular savings?
There are some fixed rate savings bonds that will allow you to pay more into your account. There are also those that will prevent you from making any additional deposits once you’ve opened your account.
Is it required for you to have a separate account with the provider?
Some of the banks and building societies have put up restrictions on their fixed rate bonds. They would usually limit the bonds to existing customers or would require you to open another savings or current account with them.
The Main Risks Involved in Investing in Bonds
The list of risks is nowhere near as long as those of other instruments. Regardless, it’s still not something you should easily ignore. Here are some of the major risks of investing in bonds.
The liquidity of bonds is far less than most of the major blue chip stocks in the market. With this, it might prove to be more difficult to sell the bonds you acquire at top dollar. This is one of the main reasons why it’s considered better to limit the individual bonds for your portfolio to those bonds that you intend to hold until maturity.
You might decide to sell off a bond that hasn’t yet reached maturity. Such time might come but something could also happen wherein you would be forced to reconsider.
Bonds can take up to five to ten years before reaching maturity. During the time you decided to buy the bonds, it might still be of higher value. But as time passes, you might consider selling off the bond before it even reaches maturity. There is a possibility that you might not get the same value you spent when you first acquired the bonds. This can prompt you to reconsider your decision and it might be advisable to hold on to it instead until it reaches maturity.
As an investor you should also be mindful of the difference in the value of bonds most commonly known as bond spread. This refers to the difference between the quoted bond value at any given moment and what you can actually get for it. If left alone without setting any precaution, it can seriously hurt you. Ergo, you should always be careful and keep a lookout.
This risk refers to the possibility of not receiving your promised principal or interest at the contractually guaranteed time. This can happen due to the inability or unwillingness of the issuer to distribute the agreed amount.
Credit risk can usually be managed by separating bonds into two broad groups, the investment grade bonds and junk bonds.
In almost every single situation, the higher the bond rating is, the lower the chance of default. This means that the interest rate the owner receives is considerably lower. The willingness of other investors to pay a higher price for the bigger safety net measured by financial ratios also plays a big role.
It’s normal to expect to receive regular interest income when you decide to invest in bonds. But there is also a danger to this expectation. There is no way for you to accurately predict the exact rate you’ll be able to reinvest the money.
There is still the possibility of interest rates dropping considerably. If that happens, you’ll have to invest fresh interest income in bonds yielding lower returns than what you‘ve been enjoying.
There are also some bonds that don’t distribute interest income as checks or check deposits. These bonds are more commonly known as zero coupon bonds. They distribute interest income at specifically calculated discount in order to par and mature at their face value. The interest will be effectively credited during the holding period. The total interest will be then be paid out all at once when the bond reaches maturity.
The possibility of the government enacting policies is always present. Whether intentional or not, these policies could result to widespread inflation.
A high rate of inflation can seriously damage your purchasing power. Owning a variable rate bond or a bond that has some sort of built-in protection can be good at times like this.
With inflation in the picture, you might end up finding yourself in a place where the prices for basic goods and services are much higher than what you previously anticipated before you receive your principal back.
The fixed rate bonds are great for those who want to guarantee that they’ll be earning interest rates at specified terms. But there are still factors you need to consider when choosing which one will work best for you. Learn as much as you can about your investment before making the final decision. That way, you could prepare yourselves with various countermeasures no matter what the outcome might be.
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