Bonds: lending your money for interest

Moneysmart's bonds page opens with the whole idea in one line: when you invest in bonds, you're lending money to a company or government. A bond is that loan, written down as a tradeable IOU. In return the borrower makes regular interest payments — called coupon payments, a name left over from the days when investors literally clipped a paper coupon to claim each one — for the life of the loan.

Two more numbers complete the contract. The face value is the set value of the bond when it is first issued — the amount the loan is for. The maturity date is the day the loan ends: hold the bond until then and, per Moneysmart, you get the face value back, on top of every coupon paid along the way. The coupon itself comes in a few shapes — fixed rate bonds pay the same steady amount throughout, floating rate bonds adjust their payments with underlying interest rates, and indexed bonds lift both the coupon payments and the face value in line with the consumer price index, which is why Moneysmart notes they protect against inflation.

Where do bonds sit in the landscape? Moneysmart files them under investments paying interest, alongside better-known term deposits and riskier cousins like debentures and hybrid securities. Its framing is that bonds can provide a stable source of income and help to diversify a portfolio, and that they're generally viewed as a defensive asset — an investment considered lower risk than growth assets like shares and property, valued for steadiness rather than spectacular gains. Lower risk, though, is not no risk — which is what the rest of this page is about.

Here is the one mechanic everyone should take away. A fixed-rate bond's coupon is locked in on the day it's issued — but the world's interest rates keep moving afterwards. Moneysmart's warning is compact: if interest rates rise, bonds offering lower coupon payment rates become less attractive investments. Why would anyone pay full price for your old bond's coupon when a newly issued bond pays today's higher rate? They won't — so the old bond's market value, the price a buyer will actually pay for it today, has to fall until its return catches up with the market.

Run the same logic backwards and you get the other end of the see-saw: when market rates fall, an older bond with a higher locked-in coupon becomes the attractive one, and buyers will pay more than its face value to get it. Price and yield — the return a buyer earns at the price actually paid — always move in opposite directions, because the coupon dollars are fixed and the price is the only part free to move. Moneysmart's measure for comparing bonds is yield to maturity: the average annual return from buying at today's market value and holding to the end, assuming coupons are reinvested at the same rate.

The crucial footnote: the see-saw only costs you money if you sell. Moneysmart is explicit on both sides of it — sell a bond before maturity and you'll get the market value, which could be lower than the face value; hold it until maturity and you get back the face value, however wildly the price wandered in between. A price dip on a bond you intend to keep is a paper loss with an expiry date. That's a luxury shares never offer — and it's the discipline that turns interest-rate risk from a loss into a footnote.

At the steady end of the ladder sit government bonds. The Australian Government issues Australian Government Bonds — also called Treasury Bonds — which offer a known rate of return if held until maturity, and listed versions can be bought and sold on the Australian Securities Exchange. States and territories issue their own semi government bonds ("semis"), which Moneysmart notes can only be bought and sold through their treasury corporations. One line from Moneysmart worth memorising: only the Australian Government can issue Treasury bonds — anyone else using that name is waving a red flag you'll meet in a moment.

A rung up in risk sit corporate bonds — a way for a company to raise money from investors to finance its business. Here Moneysmart tells you to consider credit risk: the risk that the borrower can't pay you back. If the company goes out of business, you won't get coupon payments and may not get your face value back — the promise at the heart of a bond is only as good as the balance sheet behind it. Corporate bonds mostly trade on the over-the-counter market between institutions, and the minimum amount required to buy them is typically large, which is why ordinary investors rarely meet a genuine one directly.

That gap between the two rungs is where judgement lives. Moneysmart's rule for any bond is to always balance the return against the risks before investing — when one bond offers more than another, the first question is what risk the extra return is paying you to carry. Its interest-investments overview adds a warning about labels: don't be swayed by the name of a product, because a "secured" investment may not be guaranteed — and it files debentures, bonds' rougher cousins, bluntly under high-risk fixed interest. The ladder is real; the sign at each rung isn't always honest.

The practical routes Moneysmart maps are narrower than most people expect. Listed Australian Government Bonds can be bought and sold on the ASX at market value, paying brokerage fees, and the government's exchange-traded Treasury Bonds (and their inflation-indexed siblings) put that access in ordinary trading accounts. Semis move only through state and territory treasury corporations. Corporate bonds largely live on the over-the-counter market in parcels too big for most households — and some bonds, Moneysmart notes, are only available inside a managed fund at all. Whatever the route, its instruction is the same: always read the financial services guide and the product disclosure statement before you invest. (How pooled wrappers work in general is a separate story — see the cross-links below.)

Now the honest list of what can go wrong. Interest-rate risk is the see-saw from the previous section: rates rise, your fixed coupon becomes less attractive, and the market value of your bond falls. Selling before maturity is how that risk gets realised — you get the market value, which could be lower than the face value you paid for. Credit risk is the borrower failing: if the issuer goes out of business, the coupons stop and the face value may not come back. And inflation is the quiet one — Moneysmart notes it can reduce your returns, because a fixed coupon buys a little less each year it's paid; indexed bonds, whose coupons and face value rise with the consumer price index, exist precisely as protection against it.

Notice that each risk has a shape you can plan around. The see-saw fades to nothing at maturity, so matching a bond's term to when you'll actually need the money defuses most of it. Credit risk is why the government-to-corporate ladder exists, and why the return must be weighed against the risk every time. Inflation risk is why indexed bonds and floating-rate structures exist. None of this makes bonds shares in disguise — Moneysmart's defensive-asset framing holds — but "steadier than shares" earns its keep only when you know which promise is guaranteed (face value, at maturity, from a solvent issuer) and which is merely today's price.