What is a bond?
This article forms part of our ‘investing basics series’ and covers the common terminology you’ll hear and read as you start out on your investing journey. Visit the Learning Center for more of our investing basics.
This article isn’t providing investing advice, but the broader ‘what is a bond’ topic.
That’s right – Swiss bonds are returning negative yields. You’d be losing money buying them.
And CHF hedged versions should also be considered very carefully due to the extremely low yields and currency exchange risk, you could simply hold CHF cash instead.
That said, lets move onto the basics behind what bonds actually are.
What is a bond in finance?
A bond is essentially a loan. When you buy a bond, you are lending your cash to the issuer of the bond, in return for a set interest rate over a defined term.
Examples of bonds
There are many different types (from a ‘zero coupon bond’ to a treasury – over 20 in fact) but if you’ve been asking ‘what is a government bond?’ – this is where you’ll find them. Here are a few examples of the most common bonds in the market place:
Government/Sovereign Bonds – Bonds which are issued by governments and backed by the country they are from. Think US treasury as an example, typically very low risk as they are backed by an entire government.
Municipal bonds – Issued by local governments and give investors the ability to invest in more ‘local’ activities and projects such as infrastructure, new schools, hospitals etc.
Corporate bonds – These are issued by companies and corporations. They will often have the highest yields, although are also among the most risky.
Bonds vs stocks – what’s the difference?
While you will typically have both asset classes in a balanced portfolio, the varying risk, performance and how they are structured, make for some quite big differences between the two.
For instance, the risks of bonds are generally a lot lower than stocks. Which means in times of volatility and uncertainty, bonds are less impacted by market movements – although it’s important to note they will still move in either direction, but historically less so than stocks.
Related article: What is a stock?
Deciding on the ‘right amount’ of bonds in your portfolio will depend on several factors, such as your age, current portfolio allocation, investment horizon and future goals.
You may feel you want more bonds in your portfolio as you near retirement or have a large purchase (e.g. a down payment on a house) on the horizon to protect your investment from short term volatility.
Bonds are seen more of a ‘safe haven’ in that regard.
So, let’s say if you are retired already and hold a relatively ‘stock heavy’ portfolio which is starting to feel too volatile for your liking.
In this case, you could calculate your next 5-7 years of living expenses and shift that amount into bonds to secure a steady income, whilst keeping the rest of your portfolio invested in stocks.
To keep things simple, instead of finding individual bonds to invest in, you could buy a bond fund via an ETF, which encompasses the total investable US bond market, over 8500 bonds for a fee of 0.035%, which has returned 4.15% since inception.
For this use case, bonds would ‘de-risk’ the portfolio whilst still providing a modest and more predictable return on the investment.
That said, please refer to the opening paragraph in this article on buying bonds in Switzerland. In this example, you need to carefully consider currency exposure with CHF – which could impact your returns and crank up your risk.
Related article: ‘Investing Mistake No.4 – You can’t sleep comfortably at night’
As you can see, by having a lower risk bond portfolio your returns will be a lot lower compared to stocks – there is no gain without a little pain 😉
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