Portfolio diversification is an important aspect in financial health and to reduce risk. Typically diversification is a blend between equities and bonds; most are familiar with equities but what about bonds? Let’s dive in.
What is a bond?
A bond is a security similar to, but different in key ways, to more well-known securities, such as equity and common shares. With a bond, an investor (the “bondholder”), loans money (the “principal”) to a company. At the end of the term, typically 3-5 years in duration but as long as 100 years, the company is obligated to pay back the principal in full with interest on a monthly or yearly basis.
A bond is a fundamental form of debt and is therefore often collateralized against a certain asset (mortgage for example). If collateralize, it is considered ‘secured’, and ‘unsecured’ if not.
As a bond can differ greatly, by company profile and industry, or even within a company through secured and unsecured bonds, the interest rate will differ greatly from company to company and bond to bond. What is important to understand in this context is the concept of risk and return; that is, the higher the interest rate, the higher the perceived risk of the bond.
Debt vs Equity
The rationale for the interest payment is the key difference between debt and equity investments. In exchange for an equity investment, an investor (the “shareholder”) is generally compensated through an ownership stake in the company. Whereas with a debt investment, such as a bond, an investor receives no ownership in the company, and is compensated through an interest payment.
Why would a company issue a bond?
A company typically issues bonds instead of equity because it is a non-dilutive (does not affect ownership of the company) method of attaining financing. It is generally issued by established companies, that have proven financial results. Otherwise, the interest rate required by the implied high-risk nature would likely be too high for the company to sustain.
Why would I invest in a bond issuance?
As one of the three main assets classes, alongside equities and cash, a purchase of a bond is a great way, and frankly necessary way, in order to diversify your financial portfolio. Diversification is a fundamental in building an investment portfolio, and its importance cannot be understated in maintaining financial health. Further, it provides a measure of downside protection, as bonds generally perform better than equities when the market is down, in addition to an ostensibly reliable interest rate payment.
How do I invest in a bond?
We currently have one debt offering on the platform, The Very Good Butchers. This offering is a little different, as it’s a convertible note, essentially meaning that at the end of the term, the amount of the note will convert into equity, or be repaid in full, at the company’s option. For more information on this structure, stay tuned for more posts!
Upcoming, we will have Yesterpay. They will be offering four different bonds, each with different terms (different length and interest rate). This is a more standard bond offering. Take a look at the offering documents and see what suits your investment needs!