They’re also a go-to for many investors (for example, retirees) who need their savings to provide an income (which is why bonds are among a class of investments known as fixed income).
Bonds are essentially loans that you, the investor, grant to the issuer of the loan. In return for lending the issuer your money, you’ll receive regular interest payments over the course of the bond’s term, and when the bond reaches its maturity date, you’ll receive your original loan amount back.
Bond issuers can be companies from a variety of sectors, such as communications (for example, Bell Canada), energy (Enbridge), financial institutions (Sun Life), retailers (Loblaw) and infrastructure (Hydro One). Bond issuers can also be federal, provincial or municipal governments.
The main difference between bonds and stocks is that a bond is a loan to a company (or government) while a stock is partial ownership of a company.
How do Canadian bonds work?
When you invest in bonds, you’re lending the issuer a set amount of money for a specific period of time. In exchange for this loan, you’ll receive regular interest payments at an agreed rate, plus all of your invested money at the bond’s maturity date.
The interest rate you can expect from a bond will depend on its credit rating. Government bonds are typically safe investments, while riskier investments are known as junk bonds or high-yield bonds. On the whole, the safer the bond, the lower the interest rate offered, and the riskier the bond, the higher the interest rate you’ll get.
There are several reasons why bonds feature in most investors’ portfolios:
- They provide diversification and tend to protect your portfolio from the effects of a market downturn.
- They’re usually a lower-risk investment than many others, including stocks.
- You receive regular interest payments (called distributions), so they can be used to provide you with a source of income.
However, you would rarely want to invest only in bonds, especially if you intend to keep your investments for a long period of time. Bonds typically offer considerably lower returns over the long-term compared to equities (shares in companies) and some other investment options. By relying on bonds only, your savings could struggle to keep up with inflation. Bonds work best as a means of providing income and a counterbalance to riskier investments within your portfolio.
How to invest in bonds
There are a few ways that you can invest in bonds:
Individual bonds: these can be bought directly from the government or company that is the bond issuer, through a financial advisor or a brokerage. You may be charged a commission when you buy the bond and if you sell it before its maturity date.
Bond mutual funds: a mutual fund is an investment product that contains a collection of investment securities, which provides investors with immediate diversification. These investments are chosen and managed by professional fund managers. Bond mutual funds (also known as fixed income mutual funds) can contain hundreds of bonds, and this allows investors to spread the risk of bond ownership. You can invest in bond mutual funds that focus on a variety of sectors, themes and geographical regions, such as North American, global (no geographical restrictions), high-yield and green bonds.
Bond ETFs: exchange-traded funds (ETFs) are very similar to mutual funds in that they contain a large number of investments, but they’re traded on a stock exchange (unlike mutual funds). They’re often designed to mimic a specific index, which is a measure of the performance of a particular basket of investment assets (such as a Canadian bond index or a U.S. high-yield corporate bond index). Therefore, bond ETFs sometimes don’t have professional management (apart from the selection of the assets they contain) and so can often have lower management fees than mutual funds.
You can sell individual bonds before their maturity date, though you may not receive the same amount that you initially invested in them. You could receive more or less, depending on how those bonds are trading on the secondary markets (where investors can sell their bonds to another buyer).
What are the risks of investing in bonds?
As with any investment, there can be some risks involved when investing in bonds. The issuer of the bond could default on its payments, meaning you may not receive the interest payments or even some or all of your original investment.
The chances of this happening are fairly unlikely, however, especially if you invest in government bonds from countries with high credit ratings (such as Canada and the U.S.) or investment-grade corporate bonds (bonds issued by large companies with a high credit rating, meaning they’re unlikely to default).
Also, if you invest in bond mutual funds or ETFs, you spread the risk by investing in dozens or even hundreds of bonds, so if one issuer defaults, you won’t feel much of an impact. Bond ETFs are traded on a stock exchange, however, so their value can fluctutate (though this would typically be less than fluctuations in stocks).
On the whole, when it comes to keeping hold of your original investment amount, bonds are considered the low-risk portion of your portfolio, with equities (stocks) and other more speculative investments being considered higher risk.
However, bonds can pose risks beyond losing your original investment. If you invest in very safe bonds, the interest rate is typically fairly low, so your money may lose some of its value when inflation is taken into account. Each investor needs to weigh their personal appetite for risk and invest in the kind of bonds that deliver the levels of return that they need.
How do bonds make you money?
Bonds provide investors with interest payments (called coupon payments), often paid monthly. For example, if you invested $10,000 in corporate bonds paying a 5% coupon, you’d receive $500 annually (or $41.67 monthly). This would continue until the bond’s maturity date, at which point you’d receive your original investment back.
You could also make money by selling the bonds at a profit, before their maturity date. The value of bonds has an inverse relationship with interest rates, so typically their value goes up when bank interest rates go down (when central banks make these decisions) and their value goes down when interest rates go up. If your bonds increase in value, you could sell them on the secondary market.
Any income you receive is classed as interest income or (if you sell them for a higher price than you paid for them) a capital gain. However, if you hold the bonds in a registered account, such as an RRSP or a TFSA, the income would grow without tax. In the case of an RRSP, any withdrawals would then be classed as taxable income, but with a TFSA, withdrawals are also tax-free.
The different types of bonds available in Canada
Government bonds: these include Government of Canada bonds (typically thought of as the most secure bonds available in Canada), provincial bonds and municipal bonds.
Investment grade corporate bonds: these are bonds issued by companies with very high credit ratings. They’re considered fairly safe investments (safer than junk bonds but not as safe as government bonds) with interest rates that reflect their risk level.
High-yield bonds or junk bonds: these bonds are issued by companies with credit ratings below BBB and therefore a riskier option but with typically higher interest rates.
Strip coupons and residual bonds: Bonds contain two parts: the principal (its face value) and the interest that it pays out. These two parts can be separated; a strip coupon provides the interest payments from the bond, and the residual bond provides you with the principal amount when it reaches its maturity date.
New issue bonds: these are bonds that are made available directly from the issuers (the governments or companies issuing the bonds).
Secondary market bonds: these are sold by an investor who already owns the bond, on the secondary market. Secondary market bonds could be priced above or below their par (original) value.
Bond interest rates
The size of the interest payments (the yield) you’ll get from buying bonds will depend on a number of factors, including:
- The perceived risk from investing in the bond (government bonds are typically safer than junk bonds, for example).
- Economic conditions.
- The length of time before the bond’s maturity date.
- The current overnight interest rate.
For example, in late 2024, federal government bonds in Canada were offering a five-year rate of just under 3%, and investment-grade corporate bonds were offering closer to 5%. Some junk bonds, meanwhile, were delivering interest rates in the double digits.
Bond FAQs
What is bond yield?
The yield is the return you’ll get from your investment in a bond. The yield of a bond is based on both the purchase price of the bond and the interest (or coupon) payments received each year. A bond’s yield will change if it’s traded for a different price from its face value.
What is a bond coupon?
A bond coupon or bond coupon payment is the amount of interest that a bond pays annually until its maturity date and is a percentage of the bond’s face value. The coupon does not change even if the bond is traded for a higher or lower price (in which case it would be the yield that changes).
What is a bond’s minimum investment amount?
It’s typically $5,000 for government bonds and corporate bonds, however, you can invest in some bond mutual funds for as little as $500, while there is no minimum investment for bond ETFs.
What is a bond’s maturity date?
This is the date when the money originally invested in the bond will be repaid. All bonds have a maturity date, and, depending on the bond, can usually be from a year to over 20 years from the date it was issued. Normally, the longer the term, the higher the interest rate paid.
Can I hold bonds in my RRSP?
Yes, government bonds and corporate bonds can be held in all government-registered accounts, such as Registered Retirement Savings Plans (RRSPs), Tax-Free Savings Accounts (TFSAs), Registered Education Savings Plans (RESPs), Registered Disability Savings Plans (RDSPs) and First Home Savings Accounts (FHSAs).
What does a bond’s par value mean?
Par value is the face value of a bond (its value when it was initially issued) and the amount of money that the issuer will pay when the bond’s term is up. When a bond is traded, it could cost more or less than its par value, but par value does not change.
What is a bond issuer?
A bond issuer is the organization that sells the bonds to raise money; in Canada, this could be the federal government, a provincial or municipal government or a company.
What are investment-grade bonds?
These are bonds issued by companies (or governments) with the highest possible credit rating (typically BBB and above, depending on the credit agency). These are typically considered to be safe investments, though returns are lower than with high-yield (junk) bonds.
What is a junk bond?
Also called high-yield bonds, these are bonds that have been given a lower rating by credit agencies (typically because the bond issuer has a higher chance of defaulting). They are therefore a higher risk than investment-grade bonds, however, they usually deliver a higher return.
How should bonds fit into your investment portfolio?
Bonds can provide stability to your overall portfolio because they typically move in the opposite direction of stock prices, plus they’re a safer investment, on the whole. While stock prices can rise and fall, as long as you hold on to your bonds, you’ll continue to receive interest payments and will recoup your full investment at its maturity date (so long as the bond issuer doesn’t default, and with government and investment-grade bonds, that is quite rare).
Bonds help to spread out your overall risk and limit the effects of a stock market downturn. Bonds also offer better protection against inflation than holding cash.
Bonds provide consistent income, which can be very important for retired investors. Once you’ve switched from contributing to your retirement savings to drawing from them, bonds can provide the income you need to help cover your monthly expenses.
The percentage of your portfolio made up of bonds will depend on your personal risk tolerance levels and your investment time horizon (the length of time before you’ll need to cash in some of your investments). The longer the time horizon and the higher your risk tolerance, the lower the percentage of bonds in your portfolio.
Your IG Advisor is skilled at building a portfolio that reflects your risk tolerance and investment time horizon as well as recommending the right bond products to help you reach your financial goals, such as bond mutual funds. They’ll also constantly monitor your portfolio to ensure that it’s always aligned to your financial plan.
Talk to your IG Advisor about the role that bonds play in your portfolio. If you don’t have an IG Advisor, you can find one here.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.
Insurance products and services distributed through I.G. Insurance Services Inc. (in Québec, a Financial Services Firm). Insurance license sponsored by The Canada Life Assurance Company (outside of Québec).
