The Business of Bonds: How to Buy and What's Safe
04/12/2011 10:50 am EST
Our friends at Globeinvestor.com have been getting lots of questions about bonds lately…clearly, investors are still craving safety. Globeinvestor reporter and columnist John Heinzl answers a few of them today.
In a recent Investor Clinic video, I invited readers to send me their questions about investing. Care to guess which topic came up more than any other?
Momentum investing? Emerging markets? Nope. Bonds.
So today, we’ll answer a couple of your questions about bonds. Next week, we’ll tackle a few questions that aren’t about bonds. And the week after that, we’ll take a detailed look at a small but important corner of the bond market—real return bonds.
Before we get to your questions, you may wish to brush up on the bond basics by reading my “Five-Minute Bond Boot Camp.” Or print it out and save it for later—makes a handy excuse if you’re invited to the in-laws.
I’ve been reading a lot about bonds. My question is: How do I access bond market listings (similar to the stock market)?—D.S.
The bad news is that, unlike the stock market, there isn’t a central bond exchange where transaction prices are posted for all to see. Rather, bonds trade in a decentralized “over-the-counter” market between dealers. The process is more opaque than the stock market, and leaves retail investors vulnerable to, shall we say, pricing discrepancies.
There are proposals to make the bond market more transparent, but “the fixed-income and over-the-counter markets still operate in near complete darkness,” according to investor advocate FAIR Canada.
The good news is that it’s getting easier for retail investors to peer inside the black box.
One example is canadianfixedincome.ca, a free service operated by CBID, an electronic marketplace that provides the previous day’s closing offer-side prices for a wide range of bonds, as well as intraday quotes for a limited number of securities.
“People do want to shop for the best price, so we make that easy. We put it right on your desk,” said Lawrence McCann, vice-president of CBID, a division of Perimeter Markets.
CBID’s pricing data are provided by half a dozen bond dealers, including Bank of Montreal, Laurentian Bank of Canada, and Merrill Lynch. For a fee, CBID connects these “liquidity providers” with advisors, certain discount brokers and investment counsellors who want a convenient way to shop the best prices for their retail clients.
Bear in mind that the price you see on canadianfixedincome.ca probably won’t be the price you pay as a client, because you’ll likely face a commission or markup on CBID’s wholesale prices.
CBID doesn’t cover the entire bond market—just a small part of it. The lion’s share of bond trading is done by the chartered banks, most of which don’t belong to CBID. But there are ways to comparison shop with the big boys, too.
Hank Cunningham, fixed-income strategist with Odlum Brown and author of In Your Best Interest: the Ultimate Guide to the Canadian Bond Market, recommends investors use a full-service broker to shop the market on their behalf. For do-it-yourselfers, he suggests opening two discount brokerage accounts to compare prices on the same bond (assuming both discount brokers are offering it).
Yet another place to find bond quotes is on this page at globeinvestor.com. Globeinvestor’s data are provided by CIBC World Markets.
I bought Canada Savings Bonds as a kid and never lost a penny. Now I hear people saying bonds can be risky. I’m confused. Are bonds safe or not?—B.H.
Some bonds can indeed be risky. If you own a corporate bond and the company goes bust, for example, you could lose all or part of your money.
Even “safe” bonds carry some risk. If you buy a Government of Canada bond and interest rates rise, the price of the bond will fall in the market, and you could suffer a loss if you sell. (This risk doesn’t apply to a Canada Savings Bond, however, which is a special type of bond that doesn’t trade in the open market and is cashable at its face value.)
The way around this is to buy and hold bonds until they mature. If you do that—assuming the issuer doesn’t default—you won’t have to worry about short-term price fluctuations.
Now, one could argue it’s also possible to lose money even when the investor holds to maturity. How? Inflation. Say you buy a $100 one-year bond that pays 2% interest annually, but the consumer price index rises 3%. At the end of one year you will have $102, but things will cost 3% more, so in real terms you will have $102 divided by $103—or about 99% of your previous spending power.
If watching bond prices bounce around gives you an upset stomach, there’s an antidote: guaranteed investment certificates. GICs are really just bonds that you have to hold until maturity. Because there’s no active secondary market in which to sell them, there are no price fluctuations to worry about. All you see is the interest piling up, which is comforting.
The downside is that, if you need the money in a pinch, you’re out of luck (unless you buy a cashable GIC).