Investment Bonds

Investment bonds are a way of lending money to governments or companies in exchange for regular interest payments and the return of your original investment at a future date. (MoneySmart) They are generally considered a more defensive type of investment than shares or property, which means they can help smooth out the ups and downs in your overall portfolio.

When you buy a bond, you are effectively agreeing to three main things: how much you will invest (the principal), how much interest you will receive (the coupon) and when your money is due to be repaid (the maturity date). If you hold the bond to maturity, you should receive the face value back, along with any coupon payments you have earned along the way. If you sell earlier, the price you receive will depend on market conditions at the time.

Bond prices move for a few key reasons. If interest rates rise, existing bonds that pay lower coupons can become less attractive, which can push their prices down. If the issuer runs into financial trouble, there is also a risk they may fail to make the interest payments or repay your principal. For this reason, government bonds are usually seen as lower risk than corporate bonds, although they can still fall in value in response to changing rates or market conditions.

Investment Bonds in the Australian Context

In Australia, the term "investment bond" is often used to describe a specific type of long term investment product offered by life insurance companies and friendly societies. These products combine an underlying investment portfolio with a tax structure that can be attractive for some investors who plan to invest for at least ten years or more. (Australian Unity)

With these kinds of investment bonds, the provider generally pays tax on investment earnings at the company tax rate and reinvests the after tax amount back into the bond. If you keep the bond for at least ten years and stay within the product rules, withdrawals after that point are usually treated as tax paid in your hands. This can be helpful for higher income earners, or for people who want a simple, long term investment that does not require annual tax reporting in their own return.

These products are still investments, not savings accounts, so they can go up and down in value. Returns will depend on the underlying portfolio, fees charged by the provider and how long you stay invested. It is important to read the Product Disclosure Statement (PDS) carefully and consider seeking independent financial advice before deciding whether an investment bond is right for you.

When Might Bonds Suit You?

Bonds and investment bonds may be worth considering if you:

• Want to diversify away from having all of your money in shares or property.
• Prefer a more stable investment that typically moves less than the sharemarket.
• Have medium to long term goals and can commit money for several years.
• Are looking for a more predictable income stream to sit alongside other investments.

For some investors, bonds play the role of a stabiliser in the portfolio. They may not deliver the highest possible returns, but they can help reduce the impact of large market swings and provide a clearer sense of expected income.

Ways to Invest in Bonds

There are several ways Australians can gain exposure to bonds and fixed income investments:

• Government bonds – You can access Australian Government Bonds and some state government bonds through the Australian Securities Exchange (ASX), either directly or via online brokers.
• Corporate bonds – Larger investors can access bonds issued directly by companies, while smaller investors may gain exposure through managed funds or exchange traded funds (ETFs) that specialise in fixed income.
• Investment bond products – These are long term investment products offered by specialist providers, which package an investment portfolio inside an insurance style structure with its own tax rules.

Each option has its own mix of costs, risks and liquidity. Some products can be bought and sold easily on the market, while others lock your money away for longer. Checking fees, minimum investment amounts and how you can access your money is an important part of comparing your choices.

Risks and Things to Watch

Bonds are often described as lower risk than shares, but they are not risk free. Some of the main issues to keep in mind include:

• Interest rate risk – Rising interest rates can cause the market value of existing bonds to fall.
• Credit risk – If the issuer defaults or goes out of business, you may lose part or all of your investment.
• Inflation risk – Over long periods, inflation can erode the real value of fixed interest payments.
• Product and provider risk – Different investment bond providers offer different investment menus, fee levels and features.
• Scam risk – Some scammers target Australians with fake "safe" bond offers. Always check that you are dealing with a licensed provider and be wary of unsolicited approaches promising unusually high returns.

As with any investment, it pays to compare options, understand how the product works and check that it fits with your goals and risk tolerance.

How Bonds Fit Into a Balanced Portfolio

Most diversified investment strategies combine growth assets, such as shares and property, with defensive assets such as cash and bonds. Growth assets offer higher potential returns over the long term, but can be volatile from year to year. Defensive assets tend to offer lower long term returns, but can help protect your portfolio during market downturns.

Bonds can therefore play a useful role as a middle ground between very stable cash and more volatile shares. Depending on your life stage and risk profile, you might choose to hold more bonds as you approach retirement, or use them alongside cash for medium term goals where you cannot afford large losses right before you need the money.

To see how bonds compare with other investment options, you might like to explore our guides to cash, shares and managed funds and ETFs, as well as our section on investment strategies and retirement planning.

Watch: Investment Bonds Explained

If you prefer to learn visually, this video offers a clear introduction to investment bonds and how they work for Australian investors:

Related Links

• Bonds – Moneysmart (Australian Government)
  A clear explanation of how bonds work, the main risks involved and how they fit into a diversified portfolio.
• Imposter bond investment scams – Moneysmart
  Important guidance on how to recognise and avoid fake bond investment offers targeting Australian investors.
• Lifeplan Investment Bond overview – Australian Unity
  An example of how Australian investment bond products are structured, including their potential uses and tax features.
• Investment bonds explained – BlueRock
  A practical summary of who investment bonds may suit, with a focus on tax effectiveness and long term planning.
• Insurance bond earnings and the 10 year rule – Colonial First State
  Technical detail on how the tax treatment of insurance or investment bonds works in Australia over different time frames.
• Bond – glossary definition (Moneysmart)
  A concise definition of bonds and where they sit among other investments that pay interest.