Ozbargainers,
Seeking wisdom from the investors among us.. Is investing in bonds or fixed income something you should look at to diversify or safeguard a portion of your investment porfolio? Are you trading through ASX listed ETFs, or how do you do it?
I am new to the world of bonds and ETF listed bonds so seeking some wisdom from the internet, what could go wrong.
not financial advice yada yada
Most people who invest in bonds are either using them as hedging instruments against interest rate changes (bonds go up in value as yields fall), or to provide a fixed annuity - e.g. if you are in retirement and looking to draw down on your savings over time.
Most people should invest in bonds as a means to reduce volatility across a portfolio. If you have a long term investment approach (7years +) then reducing volatility isnt really necessary - it might make you feel less stressed but if your portfolio goes down 20% in a year vs 12% with bonds, but you arent looking to sell that investment for 20 years then that blip is really irrelevant to the end game which, as you say, is maximising returns.
However if you are either (a) more risk adverse/cant handle the volatility or (b) looking at a shorter term horizon (say 5 years) then having something that reduces volatility or sequence of return risks might be worthwhile (or might not, depends on a range of factors eg if you have saved $4m, then you dont need to worry very much about volatility because it wont make much difference overall).
Then there is the question of whether a high interest savings account paying 5%+ is preferable to bonds, which are generally paying less for equal level of security. However, if interest rates drop then bonds may be preferable for the capital gains.
For OP - there are some nuances between bond ETFs and buying a bond direct and holding it until maturity. However for the majority of people a bond ETF is the way to go. You can choose between very safe (government) through to fairly safe (eg bank tier 2) to not as safe (private credit/corporate bonds with low rating). The problem with very safe is that you get only 2-3% and you can easily beat that by putting your money in the bank.
What could go wrong - if interest rates go up, the value of the bond goes down. If you buy a bond and hold to maturity that doesnt matter (you redeem the bond for the face value). If you are in an ETF, then the ETF value will go down. So bonds will not preserve capital, they will just be less volatile than equities. If you want to preserve capital, then put the money in a bank.
Just buy an index ETF
Just buy the next Nvidia and 10x your money in just a few years.
These investments are essentially just cash. Why not keep cash in a term deposit or high interest savings account? At least you can get your money out easily without trading costs.
"These investments are essentially just cash" on face value, it appears to be but they are very different from cash.
The income are should be a little higher than cash, however the capital value can fall/increase depending on the rates (returns of new bonds).
"Why not keep cash in a term deposit or high interest savings account? At least you can get your money out easily without trading costs" agree with you there for the majority of people.
Answer depends.
Also depends if you get it.
Bonds are subject to default risk, duration and rate risk to set prices.
For example the 20 year Australian Gov Bond is yield to maturity around 4.8% - 4.9% but the annual payment is 3% and trading at $75 but the value at maturity is $100. If RBA rates go back to 0.1% then you will make a bucket load on the capital gain. If rate expectations go up you'll probably have a capital loss.
Sounds like they're just another instrument for betting on interest rates.
Depends.
If you want to buy the Australian Gov 20 year bond which is $75 per contract. The gov will pay you 3% pa and you get $100 back after 20 years making yield 4.8% (approx) total it is up to you.
Bonds are highly misunderstood - have a low correlation to equities in their behaviour hence can be handy to smooth a portfolio & mitigate some volatility. They might be due for a period of decent performance as have had a shocking decade.
Did you consider managed funds?
Generally speaking, for most investors, bonds are not a good long term investment as you're not going to get the same sort of returns that you would with equities.
Most people who invest in bonds are either using them as hedging instruments against interest rate changes (bonds go up in value as yields fall), or to provide a fixed annuity - e.g. if you are in retirement and looking to draw down on your savings over time.
If you're seeking diversification, your best bet is to invest in international equities and small-caps (assuming you're currently only in the ASX). Then you could look at alternatives (e.g. REITs would be a good place to start).