Any Sense in Buy Bonds as financial instruments?

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  ESEMCE on 23/09/2014 - 12:33

  Cause they're backed by the financial security of a Government.
  You're essentially guaranteed the yield.
  Bank Deposits run the risk (albeit low risk) of the bank imploding (a la Lehmann Brothers).

  • 

    [Deactivated] on 23/09/2014 - 13:34

    +1

    Doesn't the Australian government guarantee bank deposits as well?

    Bonds are actually more risky than deposits, their value can drop if the interest rates rise.

    Conversely, if interest rates drop, their value can go up. However, the margin of increase is not enough to justify the possibility of a drop AND the low yield (I can't find anything even close to 5%).

    This is to my knowledge, I am open for correction.

    • 

      adamren on 23/09/2014 - 15:10

      Not every single bank and only up to $250k. I believe uBank falls under NAB as a NAB bank so is protected.

      There is always a chance the govt of the day can revoke/change that 'guarantee'.

      • 

        [Deactivated] on 23/09/2014 - 17:57

        I do believe the government is very unlikely (not impossible) to revoke/change that guarantee. Banks are leveraged in debt way beyond their liquid assets/reserves.

        To my knowledge, the guarantee exists to protect the banks, consumers and by extension the economy.

        Before the advent of the international stock market, quite a few banks collapsed due to lost of trust, panic and mass withdrawal of which the banks were unable to honour.

        Anyway, I do not have 250k cash lying around so I am not too worried!

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  2jzzzz on 23/09/2014 - 12:59

  No, they are now manufactured overseas and riding on people still thinking they are still made in Aus.

  • 

    sempro on 23/09/2014 - 15:37

    ha

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  adamren on 23/09/2014 - 15:12

  +1

  Not really worth it unless you have a whole lot of money. Try fiig.com.au though if you must and have at least $10k but $50 to $100k would be better, as with anything.

  Have you considered share indexes? Search for MINIs/eminis and teach yourself economics and trading.

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  silverrat23 on 23/09/2014 - 17:12

  And here I am, thinking this thread is about the underwear brand…

  sigh

  • 

    Baysew on 24/09/2014 - 14:14

    I can help you

    www.ozbargain.com.au/node/162657

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  [Deactivated] on 23/09/2014 - 17:54

  Thanks for all the replies, and I did not know bonds were so much more popular as an undergarment than as a financial instrument.

  I am already invested in ETFs and some other stocks.

  I am thinking of balancing my portfolio with some medium risk assets. I am not looking for an asset class that is better than bonds/cash. I am just wondering what is the appeal of bonds (assuming I have >50K) compared to letting it sit in your bank account earning >3.5% interest.

  Bonds would leave to vulnerable to interest movements while a savings account would provide some interest while keeping the money liquid for any opportunity.

  I guess I should bracket my question more specifically

  At the 20-200k cash range, would bonds be better than the ubank account, or any other term deposits/savings account with interests more than 3%?
  If yes or even conditionally yes, why so and based upon what condition?

  Another why of rephrasing it, given what we know about bank savings account and what we can get out of them. Are bonds really worth the risk?

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  mskeggs on 23/09/2014 - 19:52

  +5

  Bonds are likely to be a poor investment at the current time. They have been in a bull market since about 1980, that is, their price has been rising.
  They are currently pretty close to as high as they can possibly go.
  Huh?
  Bonds are priced according to their coupon, that is, the interest rate they pay. When you buy a bond you are effectively making a loan to the issuer for a set period. A few comments up thread assumed you meant government bonds, but there are a whole range of bonds issued by governments and businesses. Each will have a credit risk attached, which judges how likely you are to get your money back at the end.
  So, for example, NSW government bonds are AAA rated, because they are very likely to repay your capital at maturity, but that security translates to pretty low interest rates.
  Argentina, conversely, is nearly broke having all sorts of legal fights with previous bond holders. They have a much lower credit rating (possibly "junk" the lowest rating there is) because you are less than assured of getting your money back. Other issuers, like Woolworths or CBA have ratings in between (e.g. AA+, B- etc.).
  As you can imagine, if I wish to issue bonds - that is, get a loan from you, and I am a poorer credit risk, I must pay higher interest.
  30 years ago, it was not uncommon for a lower rated bond to pay 20% interest or more. This obviously motivated some people to lend the money in the hope they would make such big returns.
  More recently, and especially since the GFC, typical bond buyers, who are governments like China or Saudi Arabia that have large inflows of income or superannuation and pension funds around the world who have billions to invest so can't just set up a Ubank account, have been quite risk averse. That is, investing less in shares and real estate, and more in "safer" instruments like bonds.

  Now wait a sec. If there is a bucket of 100 bonds over on the desk, but 105 people all want to buy bonds, what happens? The price goes up. For example, a bond may be issued by Woolworths for $100 paying 5% (or $5 per year) for 5 years then repaying the original $100. The first investor pays $100 for it, but discovers short time later there are other buyers prepared to pay $110, so he sells.
  Now the new buyer gets the bond, including the $5 per year interest, but oh no! that isn't 5% income anymore because he paid $110 for it, and in 5 years time he will only get $100 back.

  So you can quickly see why bond prices can't rise forever. If somebody pays $125 for this bond they lose access to their money for 5 years for no profit! And if Woolies goes bust, they might lose all their money (although bond holders usually get their cash back before shareholders).

  In fact, in Europe recently demand for bonds has been so high, people have bid them up to negative returns! I think until then it was only theoretically possible a bond return could go negative, that's what a crazy time financial markets are in right now! As an aside, you might be thinking, why on earth would somebody bid $126 to get back $125 over 5 years? The main reason I think is because some investors have rules about what their portfolio make up must be, so if 105 investors are chasing 100 bonds and the failures get in trouble from the boss, this crazy pricing can happen. The other reason is if you have $800m to invest until the month after next when your office block development settles, bonds are one of the few places you can easily park a large sum and be fairly sure of getting it back immediately because the market is very liquid.
  Any hoo, back to why bonds are not a great buy, I think.

  If you have read this far, we can agree that most bonds have very little room to grow in price, so investors are bidding up even riskier bonds. I heard Mexican debt is now in the 5% range. This is absurd. Mexico should be recognised as a substantially higher risk than that.

  So with no place to go upwards, they can stay around the this price, or they can fall.
  Either outcome is poor for you.
  If there is a new financial panic of some sort - say like the Asian currency crisis in the 1990s or some other issue, bond holders may need to sell their bonds quickly. Imagine what happens when all the holders want to sell at once. In our earlier example there are only 5 other buyers out there for 100 bonds! Oh no. So the bond prices get discounted, just like Myer's 75% off winter clothes.
  When a bond seller is willing to take $50 for his $100 5% coupon bond, the buyer is effectively getting a 10% return, but if the seller was the investor who bought at $110, they have lost a lot of money.

  So in a long drawn out conclusion, the bond market is a bubble and it may destabilise the world banking system leading to another GFC or worse!
  And those who will suffer worst will be the bond holders (although everyone else would be stuffed too in a bond panic sell situation).

  So I strongly caution you against bonds as a retail investor at this time. If you want security for up to $250k, a high interest bank account or term deposit is the best option (note if you have more to invest the cap is per bank). If you want security against bank failure and government default, you probably want to invest in real metal gold (as opposed to futures and ETFs). Maybe real estate too, but it is obviously high.

  So good luck!

  • 

    tomclancy on 23/09/2014 - 23:13

    Great post. Worth the read.

  • 

    [Deactivated] on 23/09/2014 - 23:30

    Awesome just my sentiments and completely answers my questions. I thought I was missing out on something.

    So in summary and conclusion for those who are too lazy to read.

    Bonds aren't worth the associated risk compared to savings accounts (if one bothers to search for a good bank read: ubank).

    Considering mskeggs's insights, I suppose people are buy bonds just to make fit the diversification rules and/or are from countries where saving accounts do not go higher than 2 or 3%

    Thanks!

  • 

    elease on 24/09/2014 - 12:33

    I am not familiar with the condition of the bond market (and of the whole financial market as well) but in case there is some panic on the financial markets, would not investors run massively first of all from shares?

    And in case they run from shares, where would they run? Gold, tresuries, off course, but significant amount would also run into corporate bonds, would not they?

    And if you have in your portfolio substancial amount of bonds then this would improve the yeild and compensate your losses in ETFs… This is only true if you buy the bonds of companies, which are not likely to bust anytime a crisys hit and if their bonds still have scope to get dearer…

    • 

      mskeggs on 24/09/2014 - 13:14

      This is the conventional thinking, but a flight to treasuries (another name for bonds, like that stocks, shares and equities are all the same thing) in the current environment would push them negative, yields are so low because of the yet to really unwind flight to bonds after the GFC.
      The risk is if the panic starts in the bond market. Where do you go then? You could expect equities and all risk assets to be sold, and if that includes sovereign debt for US/JPY/EU there isn't anywhere to go (gold to the moon!!!!!).
      We live in interesting times, in the Chinese curse way. There is a wave of mispriced risk, in my opinion, and I can't see it ending any way but ugly in the medium term.
      Of course, that doesn't mean it won't be stupidly further mispriced in the short term ;-)
      My suggestion is to put money you can't afford to lose in high yield bank accounts, keep a balanced super fund leaning toward growth if you are under 50 and figure you will be in the same boat as everybody else, so that if things do get ugly you won't be alone, but if they don't you will still be ok.