Bonds are known as the go-to investment asset in times of great uncertainty. Looking at 2020 and now the beginning of 2021, the current pandemic we are battling is still a thorn in our flesh. The result has been tremendous economic distress characterized by unprecedented market volatility. If one wants to thrive rather than just survive, they have to think outside the box and diversify their held investment portfolios.
Bonds, whether corporate or government, offer a better opportunity to reduce the portfolio profile risks. No investment instrument is risk-free, but bonds are more stable than stocks - this is why they are the go-to asset in times of uncertainty. The question is which are the best bonds to buy? This guide highlights the best bonds to trade in 2021 also explaining why they are the best.
What is a bond?
It’s never a good idea to get mixed up in a venture you have absolutely no knowledge about. So let’s see what a bond is. The simplest definition of it is an "I owe you, IOU" issued by a government or corporate institution to raise capital. IOU is a document that ratifies a debt is owed, while you lend your money for a specified period to the insurer of the bond. In return for buying a bond, an investor gets coupons, regular interest payments, and the initial investment at the bond's maturity (face value).
Bonds are categorized under four major classifications:
- Government bonds are issued by countries or government treasuries and are viewed as very safe investments, especially if the issuing government is a major world economy.
- Corporate Bonds are issued by individual corporations or companies and are considered riskier than government bonds. The degree of risk depends on the profile of the issuing company.
- Municipal Bonds, also known as muni bonds, are issued by municipalities or states.
- Agency Bonds are issued by government-affiliated institutions.
Why would a company issue bonds instead of borrowing money from an institution? In some cases, a corporation or government requires more investment, than a single institution can fund. Bonds offer an avenue where such capital intensive investments can be supported by many individual investors: all those who buy the bonds assume a lender's role to that particular institution. The beauty of it is that the bonds are transferable to other investors if the current holder wishes to cash in, and they have not yet reached maturity. The trading of bonds before their maturity is the reason why the value of a bond fluctuates driven by demand and supply forces until it matures.
The coupon rate, which is the interest rate on a bond, is determined by the credit rating and the maturity period. Corporations viewed as most likely to default due to low credit rating, pay a higher coupon rate. These bond types are known as high yield bonds or junk bonds. They have a high probability of default, and hence, the investors demand a higher interest rate for their investment. Bonds that mature over a longer period also pay a higher coupon rate to cater for interest rate fluctuations and risks associated with inflation.
The best bonds to invest in, especially for the risk-averse, are the investment-grade bonds. These are the bonds issued by stable world economies, such as the American or German ones, and other corporate institutions featuring perfect credit ratings.
What are the trading hours for a bond?
Different investment instruments have different peak hours when they are traded in other regions of the world. However, the most defined trading session among traders worldwide is the United States trading session, driven by the New York Stock Exchange trading hours.
When it comes to bonds, the NYSE's stipulated trading hours are 8 a.m. to 5 p.m. EST on weekdays with a short trading day on holidays, which ends at 2 p.m. The aforementioned has evolved in the wake of electronic trading and its popularity to include pre-market trading, 4-9.30 a.m. EST, and after-hours trading that runs from 4-8 p.m. EST on ordinary weekdays.
Trading bonds in 3 steps
Open a Trading Account
Choose a broker that offers bonds you’re interested in and click on the new account icon on their website. Fill in the required details and validate your new account via a link sent to your email as filled. Fund your account.
Choose what to trade
Bonds can be traded in two ways, through CFDs or ETFs. Decide on the approach that suits your investment goals and trading style well.
Once you’ve decided whether you are investing in ETFs or trading CFDs, pick the bonds you are interested in and start trading.
Where can I trade bonds?
To choose a platform or broker facilitating the trading of bonds you should first decide on the approach. One can either invest in bonds or trade-in bonds.
Investing in bonds involves buying and adding them to your investment portfolio. Investing in bonds is done by directly purchasing either from the bond issuer or a bond ETF, an exchange-traded Fund. Most investors prefer bond ETF since buying directly from the issuer is capital intensive with the standard minimum investment lot being £100,000. Bond ETFs allow retail traders to buy and sell smaller lots, and hence, are more liquid.
Given the above parameters, these are the best brokers of trading bonds:
Which are the best bonds to trade?
Each trader will have their own best bonds to trade depending on their risk tolerance and investment goals. However, the best bonds to trade in 2021 offering a low expense ratio are:
- The US treasury bonds
- Germany Government Bonds
- Vanguard Bonds
- Fidelity US Bond Index
The US Treasury Bonds
The United States treasury issues bonds and so far, it has never been known to default. The US treasury bonds are divided into two broad categories:
- T-Bonds, treasury bonds with a maturity period of more than 10 years.
- T-Notes, treasury bonds with a maturity period between one and 10 years.
The shorter the maturity period is, the bigger is the coupon rate paid out on a bond.
Germany Government Bonds Germany Government Bonds are among the most popular bonds traded globally due to the German economy's stability over the years. German bonds have different names depending on their maturity period:
- Buxl is the ultra-long-term treasury bond of the German government.
- Bund refers to the long-term bond offering.
- Bobl is the medium-term bond offering.
- Schatz refers to the short-term bond on offer by the German government.
The Vanguard Bond offers two options that currently show positive annual yields:
- Vanguard High-yield Corporate Investor, VWEHX: made up of corporate bonds with more than 90% of them below investment grade. It is a high-risk bond fund with an expense ratio of 0.23% and a yearly yield that exceeds 3%.
- Vanguard Intermediate-Term Tax-Exempt Investor, VWITX: made up of a bond fund including over 11,000 municipal bonds. It has an expense ratio of 0.17% and an annual payout of 1%, but this goes up due to tax-exempts.
Fidelity US Bond Index
This is a diversified bond fund boasting a 0.025% expense ratio and annual earnings to the tune of 1.1%. It is primarily made up of treasury bonds, investment-grade corporate bonds, and collateral-based mortgages.
The Fidelity US Bond Index, FXNAX, will thrive in any economic conditions with any interest rate since it is a bond fund with over 98% of investment-grade bonds.
Expert tip on investing in bonds
When choosing the bond or bond fund to invest in, consider both your risk tolerance and finances. Always look at the yield figure of a bond: its total returns, dividends and interests, and the bond expenses.
Why trade bonds?
Bonds offer an alternative investment avenue that is less risky compared to trading in shares or forex. Bonds are also more stable than individual corporate shares or the volatile forex market. All these factors combined make bonds a safer investment instrument which is easy to trade. Unlike other assets whose value depends on multiple factors, bonds are only affected by interest rates, which makes predicting their price movements relatively easy.
No investment is 100% risk-free. Therefore, even trading bonds can’t provide absolute safety to your funds. The trick is to have a sound trading strategy with robust money management rules.
Frequently Asked Questions
Bonds are loans issued to an organization where the bondholder is a creditor. Shares refer to the percentage ownership over an organization granted at a fee invested in that organization.
Yes. Except for defaulted bonds, investing in bonds results in profits.
When it comes to government bonds, short-term maturity bonds are the most profitable. For corporate bonds, the most profitable are high yield bonds due to the relatively low credit rating of an organization.
The safest bond to trade is a medium-term government bond, especially the US or German one.
Bonds are a good beginner investment due to their low risk.
Online trading of bonds is available 24 hours a day during weekdays.