Canada Bond Investing 101

A well-rounded investment portfolio cannot do without bonds. They offer a steady stream of passive income while shielding your portfolio from the ups and downs of the stock market. To top it all off, purchasing Canadian bonds has never been simpler. About twenty-five percent to thirty-five

A well-rounded investment portfolio cannot do without bonds. They offer a steady stream of passive income while shielding your portfolio from the ups and downs of the stock market. To top it all off, purchasing Canadian bonds has never been simpler.

About twenty-five percent to thirty-five percent of my entire portfolio is invested in bond exchange-traded funds. These funds are some of my favorites to own because they regularly distribute dividends that give me access to a steady stream of income that I can reinvest. With the help of the Dividend Reinvestment Plan (DRIP), I automatically reinvest my dividends back into exchange-traded funds (ETFs) holdings, and I do this with even my core bond funds. My monthly passive income has increased as a result. In my opinion, bonds are an essential part of any investment portfolio, and new investors should make bonds a significant portion of their holdings.

Just what are bonds, exactly?

Both stocks and bonds are issued by companies to the public in order to finance the running of the company. However, bonds are not like stocks in any way, and they do not offer the same returns.

Buying stocks means becoming a shareholder in a company through the purchase of its shares. That entitles you to a cut of the company's earnings and, in many cases, a say in how the company is governed through voting rights. Bonds are a type of loan made to a company. You will receive interest payments throughout the loan's term and receive your principal back at the end of the loan. Bondholders don't have any say in the management of the company and don't get a cut of the profits.

Bonds are best conceptualized as a loan in order to grasp both their purpose and operation. What you're doing is lending money to a business with the expectation that they'll repay you plus interest by a certain date. Bonds, in essence, are just like student or car loans, except that you give money to the lender instead of the borrower.

When constructing a financial plan, why are bonds so important?

Bonds are a crucial component of any diversified investment portfolio because of the passive income they can generate.

Bond prices typically go up when stock prices go down and vice versa. In this way, bond prices rise when the stock market falls and fall when the stock market rises. As an investor, you can lessen the impact of market swings by including both bonds and stocks in your portfolio.

Bonds are also a great way to build your portfolio with a passive source of income. Bonds are ideal for investors seeking a passive income stream because they guarantee a rate of return on their investment paid on a fixed schedule. Interest on bond ETFs is typically paid monthly, which is more frequent than the quarterly payouts typical of stocks. This is why many people, as they approach retirement age, add bonds to their investment portfolio.

Key Terms

There are a few essential financial terms you must know when it comes to bonds and adding them to your investment portfolio:

  • Bonds have terms, which measure the time between their issuance and their final payment. That is to say, the length of time that the loan will be in effect. Timeframes here can be anywhere from one to twenty years.
  • Date of Maturity: The last day of the bond's term, on which you will receive your initial investment back (plus interest).
  • The annual interest rate paid on a bond, also known as the coupon rate. There is an annual return of 3% on a bond with a coupon of 3%. Most payment plans are set up on a monthly basis.

Interested in gaining a deeper understanding of financial jargon View our financial terms glossary.

The Canadian Bond Buying Process

In Canada, you can either invest in a bond fund through your brokerage account or buy bonds issued by a government or company through a financial broker.

Purchase of a Bond Exchange Traded Fund

It is recommended that Canadians invest in bonds through a bond fund or bond ETF. Bond funds may invest solely in corporate bonds, government bonds, short-term bonds, or a combination of these. If you're feeling overwhelmed by the options, go with a broad market bond fund, which typically includes both government and corporate bonds from around the world with varying maturities. A bond exchange-traded fund (ETF) is the most convenient and inexpensive way to invest in a diversified bond portfolio.

During market hours, all that's required to buy shares of a bond ETF is to go to your brokerage account, select the ETF, and buy the desired number of shares. Since ETFs trade on the stock exchange, your order will be filled immediately, and the bond fund shares will be added to your portfolio. Commissions for buying ETFs will be the same as those for any other investment product offered by your broker.

QuestradeBuying exchange-traded funds (ETFs) through Questrade does not incur any transaction fees. If you only want to buy one share, you won't have to worry about any commissions. This makes investing in bonds through Questrade simple and cost-free.

Interest accrued on bonds held by your bond ETF will be deposited directly into your brokerage account on a regular schedule, most commonly monthly. You can then reinvest this money into the bond ETF, or into other exchange-traded funds (ETFs), or even into stocks. The bond ETF's manager will reinvest maturing bonds to preserve the portfolio's allocation and income.

The MER of a bond ETF accounts for the fund's management fees and operating expenses. Most bond MERs fall somewhere between 0 and 1. 05% to 0 20%, which is on par with stock ETFs depending on the ETF provider.

Purchase of Bonds Without a Broker

How to Buy Bonds Directly

Photograph courtesy of Shutterstock

It is also possible to purchase bonds from the issuing government or company. They are not exchange-traded like bond ETFs, so you'll need to talk to a broker if you want to buy some.

Whether they are a bank, a brokerage, or another type of licensed financial advisor, these entities are collectively referred to as "your broker." You can buy bonds from them by browsing a list, selecting one you'd like to buy, and then calling them to complete the transaction. Since bond brokers typically charge a flat rate commission, it is only cost-effective to make a purchase of several thousand dollars or more. Call your broker again to make a trade and pay commissions if you want to sell your bonds before they mature.

Bond interest and principal payments will be deposited into the account you specify when you buy the bond, and you'll get your original investment back when it matures. You will need to contact your broker and pay additional fees if you decide to reinvest your bond proceeds in a different bond.

When purchasing a single bond, you will not be charged any management fees. This is because you'll need to go to the trouble of ensuring that your bond portfolio contains a wide variety of coupon rates and maturities.

Investment Bonds as Part of Your Portfolio

Choose a variety of corporate and government bonds with different maturities and coupon rates for your bond portfolio. Investing advice: spread your bets around If you want to spread your money around, but don't want to buy dozens or hundreds of individual bonds, a bond exchange-traded fund (ETF) is the simplest and least expensive option. Green Bonds are an alternative to traditional bonds and bond exchange-traded funds (ETFs) for investors who care about the environment.

Get in Free Trades When You Open an ETF Trading Account with Questrade.

Dangers Associated with Bond Investing

Bonds Aren't Always Risk-free

Stock photo by ShutterStock

Bonds are a vital component of any diversified investment portfolio, but they are not risk-free. Bonds are less likely to experience large price swings than stocks, but their value can still decrease. And there's always the chance they won't get paid back.

Possibility of Changing Interest Rates

If rates of interest were to rise, bond prices would fall. Bond prices are more volatile as a function of interest rates the longer the bond's term. Current low interest rates are predicted to rise in the future. Bonds purchased today will lose value if interest rates rise in three to five years.

Default Probability of the Issuing Bank

Additionally, the issuer of the bond may be unable to return the principal amount due to the bondholder upon maturity. Although this is extremely unlikely, there is still some risk involved, which is why bonds are generally considered a safer investment than stocks. A provincial or federal government is a creditworthy bond issuer because they tend to pay back their debts. If the bond issuer is high-risk, such as a startup or struggling company, there is a greater chance that the bondholders will not be repaid. The coupon rate is a measure of the market's expectation of the bond's expected return over its term, so it is higher for longer, less creditworthy issuers and bonds with longer terms.

Bonds, however, are a safer bet than stocks and a great way to build a passive income stream. Investing wisely in bonds can provide security for your money and a healthy return.

Conclusion

Bonds are similar to GICs in that they are both fixed-income and fixed-term investments, but they trade more like stocks. You should always have some, and buying a bond exchange-traded fund (ETF) through your broker is the simplest way to do so. Bonds are a great investment for those who want to hedge their bets against the ebb and flow of the stock market or who simply want to generate a reliable stream of passive income.

Get in Free Trades When You Open an ETF Trading Account with Questrade.
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