Investment Services: Bond Investments in Canada
Bonds serve three purposes in your portfolio: to stabilize your overall return, to provide an element of safety and to generate steady income.
Like a GIC, a bond is a debt instrument. When you invest in a GIC you’re lending your money to a bank, and in return they pay you interest. When you invest in a bond, you’re lending your money to a corporation or to a government – the issuer – for which they also pay you interest.
Like a GIC, the amount of the loan – the face value of the bond – is guaranteed by the issuer to be repaid when the bond matures. However, with a GIC, the value is guaranteed by a bank and insured by the CDIC (Canadian Deposit Insurance Corporation).
With a bond the guarantee is only as good as the issuer. If the issuer runs into financial difficulty, they may default when the bond matures. Which is one reason why bonds pay higher interest than GICs. Generally, the rate of interest you’ll earn on a bond is related to the credit rating of the company.
The expression “junk bond” refers to a bond issued by a corporation, which does not have a good credit rating. A junk bond generally pays a much higher rate of interest because the possibility of default is so much higher, which is why they must be considered a speculative investment.
Another difference between a GIC and a bond is the maturity period – bonds generally range from 5 years to 30 years. Plus bonds may be sold in the bond market at anytime before they mature. In addition, because of fluctuations in interest rates, the price of the bond in the market may be higher or lower than the face value.
That means you can make money with a bond in two ways: you can earn interest income plus you can sell it for more than you paid, giving you a capital gain.
The price of a bond, as opposed to its face value, is largely determined by the level of current interest rates and the credit rating of the issuer. As rates go up, the price of bonds on the market tend to go down.
The interest rate paid by a bond is determined by the level of current interest rates, the term of the bond (generally the longer the term, the higher the rate) and the issuers credit rating.
Canada Savings Bonds have for many years been one of the most popular investments in Canada. And with good reason. They have several unique features that make them attractive to many investors:
- they can be purchased for as little as $100 (most other bonds are a minimum of $1,000)
- they can be redeemed at face value at any time
- you can choose simple interest – you can receive regular annual payments – or compound interest – interest is reinvested and paid in full on redemption
Another type of bond that has become popular in recent years is the provincial savings bond. They have similar features to Canada Savings Bonds. Bond funds can be a good way for the average investor to invest in bonds
If you want to invest in bonds, you should hold a diversified mix of bonds. However, since most bonds are priced at $1,000 or more, it takes quite a bit of capital plus time and effort to build a properly diversified portfolio of bonds. A solution is to invest in a bond mutual fund.
For a reasonably small investment, you can participate in a diversified portfolio of professionally managed bonds. The fund manager can purchase a number of different bonds, and in denominations that offer more favorable interest rates.
Short-term bond funds can be ideal for holding money that you’re eventually going to invest. Suppose you receive an inheritance or a lump-sum distribution from a retirement plan. Although most investors would likely put those funds in a money market fund, you could put it in a short-term bond fund until you decide what you’re going to do with it. And depending on the timing, you’ll likely earn more than in a money market fund.