What are government bonds?
What are government bonds?
If you're looking to invest your money somewhere safe, government bonds are definitely worth considering. In return for lending your money to the government, you'll earn a higher rate of interest than you'll get from the average bank, but there are other benefits too.
Why do governments issue bonds?
Governments issue bonds for several reasons. These may include raising money to finance projects, boosting income for day-to-day operations, and helping fund deficits in their budgets. At the same time, governments often buy bonds to control a nation's money supply. By swapping bonds for cash, the government can increase the number of dollars in circulation, making money more plentiful and driving down the cost of borrowing. This is something many governments have done during the coronavirus pandemic to stimulate spending.
International government bonds
Like many international government bonds, Australian bonds are considered high-quality investments. This means that leading credit rating agencies believe there is minimal risk of default. At the time of writing, the Australian and US government have never defaulted on a bond payment. We don't expect them to either. However, it’s important to be aware that in some countries the rate of return is higher, but the risk of default is high too.
How do I buy and sell government bonds?
When you buy government bonds, you buy at a set or "face value.” This is the amount you're guaranteed to get back if you hold onto the bond until its maturity date. However, if you sell beforehand, you'll get back what the market dictates that day, which could be higher or lower than the face value. In addition, a small brokerage cost will be deducted from your return if you sell the bonds before they mature.
Some people are surprised to learn that bonds are valued every weekday - just like shares. In fact, the bond market is much larger than the share market. As in other sectors of the financial market, you’ll find fund managers that specialise in bonds, so if you’re interested in this asset class, you can always invest via an expert.
A safe and stable income stream
Many people opt for government bonds because they are fixed-income investments, meaning they pay regular interest – also known as coupon payments. As a result, this form of investment may appeal to you if you want certainty around your income. Additionally, government bonds are low risk and benefit from high liquidity, so they're easy to sell if you need to get your money back quickly.
Lower risk than stocks and shares
Investing in government bonds isn't as risky as buying shares or investing your capital in property. However, because they're defensive assets, it's essential to be aware that you'll get a lower rate of return than if you invest in an asset that's a higher risk. While they are lower risk, bonds still carry risks, particularly if you invest in a managed fund or want to sell a bond before it matures.
The impact of inflation and interest rates
It's important to understand that bond values are affected by inflation and interest rates. When an economy has rising inflation, interest rates go up, as do returns, but the value of bonds goes down. On the flip side, when interest rates go down the value of bonds increases.
If you're concerned about the impact of inflation on your investment, you can buy indexed government bonds. This type of bond provides some protection against rising inflation, so both your coupon payments and face value may increase.
Always diversify your portfolio.
When you make an investment, you'll always encounter a certain level of risk. Nevertheless, diversifying your portfolio with low-risk government bonds can help keep your investment on track. However, losing money from bonds is possible, and it’s something we’re keeping a close eye on as the economic climate continues to shift.