Because bonds are not like bank deposits and bonds are risky, we should first understand the precautions for investing in bonds.
A matter of misunderstanding
Because many people misunderstand that bonds sold by banks (which are just intermediaries or agents in selling bonds) are like depositing money in a bank because you get consistent interest and it is higher than a fixed deposit.
Or some are even worse because they don’t understand and don’t study and find information, only looking at the high returns they want, not considering the risks involved if they choose to invest in debentures. And if the debentures they invested in don’t pay interest, then it’s a big problem. That’s why we need to know about the precautions when investing in debentures.
Can bonds default on interest payments?
Of course, because in the world of investment, there is no investment that is risk-free. When bonds pay interest, there is also a risk that they will default.
In what cases can I default on a bond purchase?
We must first understand that “the company that issues the bonds is the company that will become our debtor” and “we are their creditor”.
If the issuer of a bond fails to do as expected, cannot find the money to pay interest as promised to the creditor like us, and has no money to redeem the bond, our investment money may become “zero”.
No, it must not be lost. If we want to get the money back, we must have the representative of the bondholders help. And we can do that by having the representative of the bondholders help. And in exchange, we have to waste time in litigation, forcing the bond issuer to sell assets to pay us. But there is a high chance that the case will be long-winded. And even if the assets are sold, there is a chance that we will not get the full amount back.
In the past, there were also private companies that issued bonds and defaulted on the contract, causing trouble for many investors. To this day, they still have not received their money back. Hopefully, one day, we will not be so unlucky as to invest in bonds of a company that failed because we were unlucky to invest in bonds of an unreliable company.
So how do we choose to invest in bonds?
“Bonds are not all bad. There are still good-rated bonds that are worth investing in. So if you really want to invest in bonds, how do you start?”
When we see news in newspapers or other media that announce the offering of bonds, we can find information from that media and, most importantly, read the prospectus. We can review the following important information:
1. Returns – This is the first thing that investors should look at, but they should be aware that the higher the return, the higher the risk. As seen in the market, interest rates are offered from approximately 3-7%. The main ones are offered as fixed interest rates throughout the life of the bond, or as a step-by-step method, meaning the longer you hold the bond, the higher the interest rate.
2. Investment period – The duration of bonds with a long holding period will give higher interest than bonds with a short holding period, such as 3, 5, 7, 10 years or more. For example, there is a type of bond that is similar to capital redeemable when the company is dissolved ( perpetual bond) , which is similar to holding shares, i.e., holding them indefinitely with no expiration date.
It may be necessary to wait until the issuer goes out of business before redeeming. A caution when investing in this type of bond is that you must also consider the purpose of your need for the money. Don’t make the mistake of investing in long-term bonds but need to use the money in the short term.
3. When will the interest and principal be returned? – You have to look at how the bond that they offer pays interest to us, for example, every 3 months or 6 months. As for the principal, the bond will always pay back the principal on the last day of the bond’s term. For example, if the bond has a term of 5 years, the principal will be paid back after 5 years. However, in some cases, some bonds may specify the condition that “there is a condition for early redemption”.
This means that the issuer of the bond has the right to request to repurchase the bond issued in full before the due date, and we will receive interest calculated until the date the issuer exercises the right to redeem, in which case we will not receive interest in the future.
Issuers often exercise their right during periods of low interest rates to redeem in order to issue new bonds that pay lower interest. We will lose the opportunity to receive interest that is higher than the market interest rate. This creates a risk called call risk, which is often seen in perpetual bonds.
4. Do not misunderstand that the seller of the debenture is the issuer of the debenture (our creditor)!! – The debenture that we will buy from any bank may not be the debenture issued by that bank. Therefore, we must look at the risk of the debenture issuer as the main factor, not the seller of the debenture. The risk of the debenture issuer is important because it affects the ability to pay interest and repay the principal to us. Therefore, we must find information and study it in detail as well.
What is the financial status of the company issuing the bonds? How is their management? Are the executives trustworthy? What is their potential or ability? What is their management history? What has the company’s past performance been like?
In addition, it should also be considered how risky or volatile the business or industry the issuer is operating in is, whether the economic or political situation has an impact on the issuer’s business, what the future business outlook will be, and how competitive it is, etc.
5. Credit Rating – Issuing bonds requires a credit rating, which will tell us how capable this bond is of repaying our debts, such as:
- The group with high credit rating, low risk and low return are called Investment Grade Bonds, which are BBB and above (BBB, A, AA, and AAA).
- The group with low credit rating, high risk and high return are called High-Yield Bonds such as D, C, B, and BB.
- The group with low credit rating, high risk and high return are called High-Yield Bonds such as D, C, B, and BB.
- The investment grade group has a lower risk of default but also has a lower return, according to the principle of “high-risk high return”.
However, credit ratings can change because as time goes by, it is possible that other factors may affect the company’s ability to repay debt, which will cause credit ratings to change as well.
Credit ratings can change if there are factors that affect the company’s ability to repay debt. Therefore, investors must continuously monitor the bonds they invest in and must also see whether the credit rating belongs to the issuer or the instrument.
This information is just a basic guideline on the precautions for investing in bonds, which we can use to consider the bonds that they have presented.
Therefore, before investing, we must study the conditions carefully, which can be read further in the prospectus or ask questions to the officer who sold the bonds to us. You can ask questions because they know the bonds better than we do. Or visit the SEC website.
For other articles about bonds , you can read more at:
Bonds are not a loan for investment. So what exactly are bonds and who are they suitable for?
