Can a private investor make money on the bond market?
When we try to put a private investor in the realities of modern financial markets, the first thing that comes to mind is bank deposits. You can’t argue with this, and the deposit is indeed the most common and, as many people believe, almost the only investment instrument worthy of a private investor.
However, having argued with these “many”, we will also recall investments in mutual funds, as well as in individual stocks. They write and talk about this a lot, they do much less, but still this direction is also very well studied and described, all the pros and cons of this kind of investment are dismantled. But if you suddenly ask anyone about investment in debt instruments – bonds and Eurobonds, then this will cause at least surprise and bewilderment. How? Bonds? No, this is for professionals!
Although, if you recall the not so long history of the Russian financial market, you can find a period when bonds were very popular not only among professional participants of the securities market, but also among private investors. This is the period of the mid-90s – the heyday of the market for government and municipal bonds – T-bills and MKO. Oh, and gold were the times with yields of 100, 200, and sometimes even 400% per annum! It ended, however, very sadly – the collapse of 1998! But … because it was the same! And private investors felt very comfortable back then. So what is stopping a private investor from entering the market and trying to earn a decent profit?
Bonds are one of the most ancient instruments of the financial market, which existed even in those times when there was no mention of any stock market. In essence, this is an ordinary IOU, which is given to the investor who bought it, that is, he lent money to the issuer. The global bond market is huge and several times larger than the capitalization of the entire global stock market. Bonds are very popular among both professionals and private investors. But it is there – “for them.” And here, unfortunately, only a few are entering the bond market. The main reason for their unpopularity among Russian private investors is primarily the lack of awareness of this financial market instrument and its advantages over bank deposits.
Where do bonds come from?
Now the bonds have become a standard and, perhaps, the most simple security. When the issuer (i.e., the borrower) issues bonds, he informs what profit their buyers (lenders) can receive. For example, a bond is issued for 5 years, the coupon income (we will talk about it later) is paid each quarter. This means that every three months the buyer will receive interest on the borrowed money, and in five years the full amount will be returned to him.
But it is not necessary to wait for the entire term: if the bond is circulated (traded) on the stock exchange, then it can always be sold at the current price, taking into account the remaining time to maturity. However, if at the time of sale there is, say, a bad economic situation in the country, or the issuer feels “bad”, then the price may not only rise, but even fall. Selling bonds at this point will bring a loss to the owner. And yet, the fundamental difference between a bond and a stock and the advantage of the first over the second is that the bond is an urgent security with a specific circulation period. When this period ends, the issuer must repurchase the bonds at par. That is, even if the price of a bond locally went down at some point, it would still be worth 100% by the maturity date.
The action is a perpetual security. If it fell in price, then it is unknown when it will return to the previous level. This implies investment advice for non-professional players: do not buy bonds with long maturities (5-10 years), but rather buy bonds with maturity within 1-2 years. If something happens in the market and you cannot sell bonds at a profit at the current price now, then you can wait for the repayment – for this you will have to “suffer” for several months or, in extreme cases, just a couple of years.
The issuer of bonds can be a variety of legal entities – and small LLC and large corporations. In addition, individual municipalities (municipal and republican authorities), as well as state authorities can issue bonds. In Russia, the issuer of OFZ (federal loan bonds) is the Ministry of Finance of the Russian Federation.
How much can you earn now in Russia on bonds?
The yield of bonds depends largely on the issuer. The higher the reliability of the issuer, the lower the yield. And vice versa…