Are bonds a good investment?
Yes, bonds are a good investment for those that want to avoid investing in stocks.
Have you heard about bonds on business news and then rolled your eyes because you don’t understand what bonds are?
Do you know how they work?
Do you know that you can start investing in bonds today and grow your income?
I learned about bonds in my high school years.
What fascinated me about bonds is the fact that we can lend money to the government to fund government activities and then get paid back for this investment.
This piece of information about bonds fascinated me.
My growing curiosity about bonds and other investments keeps growing as I want to grow my wealth.
Bonds are a secret goldmine for anyone who wants to invest their money for good returns.
A lot of people say that bonds are a simpler investment option when you compare them with stocks, and with good reason.
There are so many surprising benefits that you can get out of investing in bonds. For example, there is less risk volatility and you get steady returns.
Getting into bonds investment is a wise decision for newbie investors in Kenya.
In this article, I’m going to share with you what bonds are and how they work.
I will also take you through all the benefits of bonds and the disadvantages of bonds that you should know about.
DISCLAIMER: I am not a financial advisor or investment banker.
I am a curious mind with a zeal to increase my wealth and leave generational wealth to my kids.
Kindly, read these financial articles and then consult and keep learning about each topic that interests you.
I also write these financial articles to simplify the complicated financial words.
Every complicated financial article discourages me from learning about investments.
I know a lot of Kenyans are discouraged to learn about investments because the language isn’t understandable.
We want to build generational wealth, how can we when we don’t understand the terms of why we MUST invest in ourselves and the future?
I try as much as possible to simplify these articles.
You can keep chatting below or if you’re an investment banker, chime in with your wisdom.
Otherwise, happy reading and learning.
What are Bonds?
A bond simply means money that you lend for which you will get back with interest upon maturity.
A bond is a debt security, where the borrower (bond issuer) issues the bond for purchase by the lender (bondholder).
Bond issuers include the government, government agencies, banks, non-bank financial institutions, corporations, cooperatives, sovereign entities etc.
The bond issuers need these funds to finance their needs.
For example, the government needs money to pay for national debt or cater for national expenditure while corporations and cooperatives need money to grow and expand their business or acquire new corporations.
Regardless of the reasons, you will lend your money to them after which you will earn interest when your investment comes to maturity.
How Do Bonds Work?
I will explain this in the simplest terms possible.
Like I said earlier, a bond issuer may need funds to meet different needs.
Bond issuers can be the government or even corporations.
The bond issuer then issues the bond for purchase and you as the bondholder will be expected to lend a sum of money to the bond issuer.
You are then entitled to receive interest payments plus the capital repayment of the initial principal amount deposited at an agreed date in the future.
When this agreed date arrives, your bond is said to have matured and you will be paid the total amount of money you invested in these bonds.
This is the basic dynamic of how bonds work. Following on, I will take you through what you need to do to invest in bonds today.
What are the Types of Bonds in Kenya?
If you are looking to invest in bonds in Kenya, you need to know the bond options available to you.
There are two types of bond options offered by the National Treasury that are available for investment in Kenya: Treasury bills and Treasury bonds, otherwise known as T-bills and T-bonds.
- Treasury bills are sold by the government through the Central Bank of Kenya. They are short term investments which are sold at a discount. These types of bonds are auctioned weekly and their maturity ranges between a period of 3 to 6 months. You need approximately Ksh. 100,000 to invest in treasury bills.
- Treasury bonds are medium to long term investments also sold by the government through the Central Bank of Kenya. Treasury bonds can last a period of 1 to 2 years until maturity. You need to have Ksh. 50,000 to start investing in treasury bonds.
Before you start investing in either of these bonds, you need to have a look into each and every one of them and find out what bond meets your preferences.
How Do I Invest in Bonds?
Do you want to start investing in bonds?
Are you wondering how you can get started with bonds?
It is important to note that you can invest primarily or invest secondarily with bonds.
With primary investments, you have to invest directly to the Central Bank with no third party involved.
All you have to do is open a bank account with a commercial bank in Kenya and a Central Deposit System account with the Central Bank.
When you meet the qualifications, whether you are a Kenyan or a foreign citizen, you can proceed to invest directly in government securities with the Central Bank.
With secondary investments, you will be investing with a bank which will do all the transactions for you.
You will also need the services of a Central Deposit System agent, but you will have to incur additional fees for that. Here is a simple guide for you to start investing in bonds today.
Figure out what you want to invest in
This is an important thing to do before you start investing in bonds.
There are two bond options available for you to do your investments in Kenya.
You have to be sure that this is what you want and that you are able to commit in the short or long term to the investment process.
A lot of people don’t know what they want to invest in and it’s a bad decision to take a plunge into any investment without knowing what’s in store for you.
Always figure out if bonds are what you want to invest in and have a solid reason to back up your decision.
Choose your bonds wisely
There are two types of bonds that you can invest in if you are in Kenya: the T-bills and T-bonds.
When you are choosing the bonds you want to invest in, you must consider the amount of money you are willing to part with, your risk sensitivity and the time frame for which this investment will carry over.
For example, Treasury bonds are medium to long term investments which need less capital investment, unlike treasury bills.
Always do your research and do consultations if you are not sure about what type of bonds to put your money into.
There is a lot of information on the Internet that can help you with this.
You can also hire a Robo advisor to take you through the dynamics of both bonds and see what best fits your needs.
Open an account with the Central Deposit System
The next thing you want to do is open an account with a commercial bank and a Central Deposit System (CDS) account with the Central Bank.
You cannot invest in bonds without having this account.
This is where all the purchases of bonds by the bond issuer will be seen.
Once you have opened your account at the Central Deposit System, you can proceed and choose your preferred bonds.
Fill in your application
You also have to fill in a bond application to show that you are ready and willing to lend out your sum of money for a given period of time until maturity.
This application is going to be required by the Central Bank and the bond issuers in case of any legal problems. It will be a good reference point for the terms of the purchase of bonds.
What are the Advantages of Bonds?
You ask: why do I need to invest in bonds? There are benefits that you get when you invest in bonds today. Here are some of the reasons why you should start investing in bonds.
This is one of the best things with bonds.
You are always sure to get steady returns.
A lot of people say that this is one of the most attractive features of investing in bonds.
You don’t have to worry about how you are going to get your returns because it is always definite.
You will get your full capital repayment plus the interest accrued payment.
If you want to live a financially stress-free life, you should definitely start investing in bonds today.
First of all, it is important to note that just like any other investment, bonds do have risks.
The only thing that is to your advantage is that bonds are less riskier compared to stocks.
You do not have to worry about there being any fluctuations or variations in the market.
You cannot lose it all when you invest in bonds.
One thing you know for sure is that you will always get back your capital repayment upon the maturity date.
In case of risk resulting in loss, the impact is always little and salvageable.
Bonds are better investments
Bonds are better investments compared to stocks.
When you are faced with an investment decision of whether to invest in bonds or stocks, bonds are always the better option.
These investments are much more “relaxed” and you do not have to worry about losing your money.
Bonds are rated based on risk level.
This means that you don’t have to worry about instances of bond mispricing.
The interest rates and prices of bonds are always clear and accurate.
This is very beneficial for you, especially if you want to budget your money in regard to investing in bonds.
You stay ahead of inflation
Unlike saving, when you invest in bonds, you never have to worry about the devaluation of your money in later years.
Government bonds thrive on current economic development. As the economy grows, then your money grows along with it.
You stay above inflation because your money will always increase in value.
Growth with the economy
As the economy grows, so do your gains from investing in bonds. Every economic boom assures you very high profits in return.
And since you can stay above inflation, you don’t have to worry about your money losing its value over time.
What are the Disadvantages of Bonds?
These are the problems and challenges that you will face when you start investing in bonds.
Bonds yield lower returns than stocks
Bonds generally yield a lower return than stocks.
High risk generally means high returns.
With less risk in bonds, you are not going to expect high returns.
You also have to plan to invest in the long term to get high returns with bonds. Stocks can give you high returns when you invest in the short term.
Bonds also have fixed returns.
This means that you cannot expect to get above the calculated amount of money you are to receive when your bond matures.
You are not able to earn more as you keep investing.
You only get the amount as specified by the bond issuer.
This is not a good way to grow your income and build long term wealth.
Stocks, however, do not have fixed returns and you can always earn either more or less, depending on the market movements.
Defaults can occur
Sometimes the bond issuer is going to default on payment.
This is something that you should know when you go into bonds.
It can be frustrating when you expect to get your money at a certain period, but when you check your account there’s no money deposited, so you have to wait another few days or even months to get your capital repayment plus interest earned.
Always keep an open mind and prepare yourself for this possibility in case it happens.
Learn to manage your expectations with every type of investment and you will have an easier time going through the investment process without quitting.
A large investment sum is needed for bonds
You need a lot of money to start investing in bonds.
On average, the lowest amount of money you can use to start investing in bonds is approximately Ksh. 50,000.
This also depends on the type of bond you want to invest in.
Some bonds go higher than that.
If you have a low budget, you may want to go for investment options that fit your financial needs.
You can also start saving towards this goal or come together as a group of people and contribute funds towards this investment.
You will not only save your money but also contribute little money as capital and then get high returns.
Bonds are less liquid than stocks
Bonds are generally less liquid than stocks.
If you are planning on selling a bond or you are trying to get your money back before the maturity date, chances are it will be very difficult or nearly impossible for you to do it.
With stocks, you are capable of selling your stock market share at any time.
Prepayment basically means that you get your debt settlement in advance of its official due date.
What this means is that you get your capital repayment before its due date.
Although not all bonds have prepayment risk, in case it occurs, you risk not getting all the yield from investing in bonds.
This is something that you need to really think about before you start investing in bonds.
Interest rate risk
This risk is also called market risk.
When there is a change in the interest rate in the market, this risk may increase or reduce the market value of a bond you hold.
Interest rate risk increases the longer you hold a bond.
It is important that you consider this risk before you choose the type of bonds you want to invest in.
FAQs on What are Bonds and How Do They Work?
The following are the most asked questions about bonds and how they work and they are:
Are bonds a good investment?
Yes, bonds are a good investment for those that want to avoid investing in the stock market.
How do bonds work?
Bonds work like this: you give the issuer of the bond a loan which they agree to pay on a specific date with interest. Bonds don’t you the ownership rights of a company, stocks do.
What are bonds?
A bond is debt security.
Can you lose money investing in bonds?
Yes, you can lose money in bonds.
What are the disadvantages of bonds?
The cons of bonds are:
Rising interest rates
What can I buy instead of bonds?
You can buy the following instead of bonds:
Real estate investment trusts (REITs)
High yield savings accounts
What are the types of bonds?
The types of bonds include:
Are bonds better than stocks?
Bonds are less volatile and risky than stocks but it’s wise to invest in both.
Why should you not invest in bonds?
You should not invest in bonds when you expect the interest rates to rise.
What’s the difference between a bond and a loan?
The difference between a bond and a loan is:
A loan – you get funding from a lending institution like a bank
A bond – obtains money from the public when a company sells the bonds.
Business reports show that bond investments are expected to skyrocket because the government and corporations want to get rid of national debt and open up to newer markets.
This should show you how much your money is needed.
You will be glad that you made this decision today to invest in bonds, once you start getting your share of the profits.
Bonds are a more promising and less risky investment that will benefit you, especially in the long term.
You do not have to worry about the safety of your money because you are always sure that your money is secure and that you will get steady returns.
You also have to know that just like any other investment, there are some risks in bonds.
The good thing is that it is at the low end of the risk spectrum.
Bonds are one of the simplest investment options for newbies.
You can hire an investor or consult with a financial advisor and see what works for you.
If you’re a newbie bond investor, keep on reading and learning how bonds work.
Remember, you can combine bonds and stock investments.
Do you understand what bonds are and how they work?
Would you invest in bonds?