Are you looking to invest in corporate bonds? Not sure how to select the right ones. Take a look at the top five factors that will guide you in making the right decision.
With fluctuating interest rates and prevailing uncertainty, shares have lost their charm. This makes investors look to bonds as a safe and smart investment option. This increase in the purchase of bonds has led several successful national and international corporate firms to introduce bonds in the Indian market.
Before you begin, take a few minutes to understand the differences between bonds and stocks.
When you buy a stock or share in a company, it means that you own a percentage of the firm. On the other hand, bonds represent a long-term debt you have provided the corporate. It means that the company is obliged to pay the principal amount back to you after a particular period.
With so many attractive bonds on sale, how do you select the right ones? Here are a few factors that you have to consider before investing in corporate bonds.
- Creditworthiness
One of the major risks that you face when buying bonds is the default of payments. It could be either non-payment of the principal at the time of maturity or late payments. Before you invest in bonds, take a look at the rating assigned by the authority agencies for the corporate.
A higher rating means that the company has better credibility and thereby indicates lower chances of defaulting. On the other hand, a lower score means that you face greater risks when you buy the bond.
Apart from the payment defaults, agencies also consider several other factors before assigning the rating to a particular firm. For instance, if the industry of the corporate is in turmoil, it affects the final score.
So, the rating helps you to evaluate the firm’s creditworthiness.
- Look Beyond Ratings
Yes, this goes against the first factor. While ratings give you a fair idea about the company’s solvency, several other factors can put your investment at risk.
For instance, if the business goes in for a structural shift or change in management after you have purchased the bond, it places an additional burden on the issuer. This increases the risk profile of your bond thereby reducing its price.
So, instead of solely trusting reviews, scout around for other factors like the performance of the company in the market, the overall reputation of the industry and other inside news before making your investment.
- Be clear about the Exit Options
This is a significant factor that plays a crucial role in the value of the bonds. Always ensure that the bond’s maturity period matches that of your investment horizon. This is because if you sell a bond prematurely, you’re likely to be exposed to the volatility of interest rates.
For instance, when the interest rates rise, new bonds will automatically offer higher rates of interest compared to the bonds you have in hand. This will reduce the selling price of your bond.
- Stay away from Complex Bonds
Several bonds in the market offer additional features like the call, put options. Though this offers added control and convenience, they expose you to higher risks.
For instance, with the call option, the issuer can buy back the bond before the maturity date. This works to your disadvantage when the interest rates fall. So, avoid complex bonds to prevent such scenarios.
- Be Clear of the Risk-Return Balance
While there is no exact rule of thumb to predict the exact return earned by a particular bond, you can compare similar bonds in the market to gain a fair idea. This will help you to make the final judgment whether it’s worth buying a particular corporate bond or not.
It’s no doubt that corporate bonds are a smart investment option for savvy investors. However, you must make yourself well aware of the prevailing market conditions to help you choose the right ones.