What is a bond? If you’re new to investing or just a curious bystander, you might be wondering exactly what these intangible assets really are.
To put it simply, they’re an important fixed-income financial instrument for any portfolio
But are bonds worth putting your hard-earned cash into? What are the pros and cons of adding them to your portfolio?
We’ve taken a hard look at bonds for Canadian investors and compiled all the information you need to make smart investment decisions.
What is a bond?
To answer the “what is a bond” question simply, a bond is best thought of as a loan between a company or government organization and an investor. The idea is that it pays a fixed interest rate in return for your investment, which is why they’re sometimes referred to as fixed-rate investments.
Since they’re seen as a safer place to put money, many investors buy bonds to complement stocks. But that safety typically comes with a lower rate of return.
How investment bonds work
At the basic level, there are really 4 types of bonds in Canada:
- federal,
- provincial,
- municipal, and
- corporate.
All 4 types have one purpose: to raise money for a specific project, be it for government programs, company projects, or building schools.
For a minimum investment, an investor loans their cash to the issuer of the bond for a limited amount of time. The terms can be:
- short term: these are often set at 6 months,
- long term: 10 years, or
- anything in between.
The time frame for returns can vary, depending on who issues the bond and their reasons for issuing it.
Diversifying your portfolio with ETFs and mutual funds can be a convenient and valuable way to enter the bond market.
The advantages of purchasing bonds this way include:
- lower fees (usually),
- lack of a minimum holding period (which means you can sell them as soon as you like),
- smaller minimum investment required (compared to buying individual bonds), and
- greater diversification (leading to less volatility).
Some bond ETFs even offer dividends on a monthly or quarterly basis.
How to make money with investment bonds
The essential idea behind holding bonds in your portfolio is to offset any volatility with your stocks. There may be moments in history where this sentiment isn’t true, but it should provide balance for the swings in the market.
The catch, though, is that you typically don’t make as much profit with bonds as you do stocks – they simply have lower rates of return in general. There are instances where bonds offer a fairly high rate of return – but caution is necessary as these often come with significant risk.
Overall, bonds have an inverse relationship to central bank interest rates. When rates go up, bond prices typically go down. And when rates are down, bond prices leap up.
And there’s a name for the risk associated with changing interest rates: interest rate risk.
This typically only hurts the price of bonds in the short term. When looking at the bigger picture, bonds can be reinvested at higher interest rates as they mature, which can increase your returns.
Why investment bonds are a good addition to your portfolio
So why choose to have bonds in your portfolio? For one, the more diversified a portfolio is, the more likely any major economic downturns will just be a blip and not a major event.
Typically, bonds are guaranteed to provide returns on your investment. And as mentioned earlier, even though the guarantee of return is lower, it still helps to offset volatility.
Bonds can become the part of your portfolio you can count on to ride out any economic shocks.
7 types of investment bonds in Canada
Essentially, investment bonds come in 5 types. Some are more recommended than others, depending on their risk level.
Corporate bonds/investment-grade bonds
Corporate bonds are issued when a company is seeking a loan from investors and offering up security to back the issuing of these bonds.
It’s usually only large, profitable companies that are able to offer these, and the bonds are usually held for a significant period of time. In some cases, maturity can take as long as 30 years or more.
When a company offers an unsecured bond, it’s called a debenture.
Take Algonquin Power & Utilities Corp, for instance. Last year they offered Liberty Power Debenture, a 10-year bond that matures in July of 2031. It offers a return of 2.85% and is being issued under the company’s Green Financing projects.
The purpose of this debenture is to fund renewable power and clean energy technologies.
High-yield/junk bonds
High-yielding or junk bonds are those offered by companies with lower credit ratings. They offer a higher yield on maturity simply because they come with a higher risk level.
These are most often purchased through ETFs, which means you’re a bit more protected by the other bonds in the group if one of them defaults. A high-yield bond does offer a higher payout – the companies that offer them have to provide a higher return if they want investors to take the risk.
And these are still safer than stocks since the payout is consistent each time.
However, if you’re new to investing with bonds, this might not be the type you want to start with. Even seasoned investors sometimes misjudge the associated risk with junk bonds.
Foreign bonds
When a corporation or government from a foreign country issues a bond in another country’s market, it’s called a foreign bond. They can be appealing to investors as they provide considerable opportunities for diversification and there are no issues with exchange rates.
Like junk bonds, foreign bonds involve significant risk and therefore have higher yields than most domestic bonds – interest rate risk is a significant factor with this type of bond too.
If you’re considering a foreign bond investment, you should study the source country’s economy and the stability of its government. There’s always the danger that the issuing country won’t have the money to cover the debt and you’d face a considerable loss.
Foreign bonds are typically purchased through an online broker or investment firm. It’s also possible to buy foreign bonds issued in Canadian dollars as well as the currency of the issuing country.
When these bonds are issued in Canadian dollars, they’re often referred to as Maple Bonds.
Strip bonds and residual bonds
When a bond issuer separates and sells the interest payments and the principal of a loan individually, strip bonds (or strips) are created. These individual strip bonds are sold at a discount but still mature at the same time and for the same amount.
Generally, the further away from the date of maturity, the larger the discount the buyer receives. And while there’s no payout until maturity, annual interest still accumulates, so strips tend to have higher yields than other bonds.
There’s less reinvestment risk with strip bonds since there’s no cash flow until the bond matures.
Investors in Canada find this type of bond attractive for several reasons.
- The discounted price is appealing and convenient.
- They’re guaranteed to pay out the exact principal amount.
- Investors can still sell them at any time, even though it would likely be at a loss.
- It’s relatively easy to buy several and stagger them based on maturation date, so you receive reliable payouts on a regular basis.
Treasury bills
Also known as T-bills, these bonds are issued by and fully backed by federal and provincial governments. This lends them a high level of security, which, in turn, makes T-bills a solid and popular investment choice.
Investors can purchase them at a discount – which, in this case, means they’re sold for less than their actual value but the eventual payout is on par with the true value. So, if you pay $950 for a treasury bill that’s worth $1,000, the government will pay you the $50 difference when you sell it back for the full $1,000.
Of course, if you sell before maturity, you won’t collect that full amount.
Since T-bills have a guaranteed return, they’re considered a very safe investment. However, their returns aren’t usually very large. It’s also considered taxable income and so must be reported on your tax return.
Government bonds
Government bonds are one of the most widely discussed types on the financial market.
There are 3 types of government bonds in Canada.
Government of Canada bonds
These bonds are backed by the federal Government of Canada and are basically risk-free. You can find government bonds with a range of terms, anywhere from 1 to 30 years, and they can be sold at any time.
Even so, it’s still best if you wait until maturity. The minimum investment amount for government bonds in Canada is $5,000.
Provincial bonds
As the name suggests, provincial bonds are offered by Canadian provinces. Much like federal bonds, provincial bonds are basically risk-free. With minimum investments of $5,000 and a maximum of $50,000, maturation can take anywhere from a few months to 30 years.
Provincial bonds typically have a higher yield than federal government bonds and have a wider range of terms and interest rates.
Municipal bonds
Municipal bonds are bonds offered by major Canadian cities, counties, and even school districts. From Toronto to Vancouver, these bonds are direct investments into the cities we love and do business in.
Their yields can vary as compared to provincial bonds of similar quality, and they’re not necessarily guaranteed by the issuing province. But the minimum and maximum investment amounts are the same as provincial bonds, as are the term lengths.
Canada Savings Bonds and Canada Premium Bonds
Canada Savings Bonds and Premium Bonds were once a way for average Canadians to invest and save money, but the program is now defunct.
The Canada Savings Bond program was launched in 1946 as a way to fund the postwar recovery effort. Really, this program played a huge role in shaping our country into what it is now.
The final Canada Savings Bonds reached maturity in December of 2021. If you’re still holding onto some Canada Savings Bonds, you can still redeem them either through the CSB website or at a Canadian bank or financial institution.
How to invest in bonds in Canada
The best way to invest in bonds in Canada is either through an online broker or your investment advisor.
Buying investment bonds with an online broker
When using an online broker, you can invest in bonds by buying the direct bond or purchasing an EFT that specializes in bonds.
Be mindful, though, that not all ETFs are created equal – so do your research before choosing the best ones for you.
Luckily, CIBC Investor’s Edge is the best online broker out there, and they make it easy. The commission fees are low and there are plenty of accounts to choose from, and these accounts can hold a large variety of investment types.
Learn more about this product here:
This online investment brokerage is owned and run by CIBC, and is targeted towards people who are interested in managing their own investments, learning about how to manage their own investments, and people who do investment management for a living. With relatively low fees for trades, and discounts for students and active traders, this is a service worth looking into.
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- TFSA
- RRSP
- RESP
- RRIF
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- PRIF
- LIRA
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- Partnership
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- GICs
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How to buy investment bonds directly
Investors can also go directly to the source and purchase bonds from the corporation or government issuing them. This can be an appealing option for those hoping to remove the middleman’s commission fees.
But this method comes with drawbacks. Since individual bonds aren’t traded on the stock exchange, you’ll still need to work with an investment broker.
This method can take longer than going through an online broker. Patience is key.
Investing indirectly through bond ETFs
But by far and large, most Canadian investors purchase ETFs that track a specific type of bond.
Whether you’re looking at corporate, short or long-term, or a combination of bond types, there’s an ETF that’ll meet your needs. And since ETFs usually have some kind of monthly payout, you can use these funds to invest in even more ETFs, making this option both convenient and valuable.
You can save quite a bit of money on your investments by using a discount brokerage like Questrade. In fact, you’ll actually be able to make bond purchases for free when using their platform.
Learn more about this investment option here:
Questrade is one of Canada's top online investment platforms. With very low fees, including no-fee ETF trading, commission-free stock trades, and plenty of investment types, Questrade just about covers it all.
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$25 GeniusCash + $50 bonus for funding a new account, and $0 commissions on stocks & ETFs- Excellent array of investing and trading tools
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- CFDs
- Mutual Funds
- Bonds
- GICs
- International Equities
- Precious Metals
$25 GeniusCash + $50 bonus for funding a new account, and $0 commissions on stocks & ETFs3 benefits of investment bonds in Canada
So why should we have investment bonds as part of our investment portfolios?
For one, they can provide a low-volatility option for your portfolio – and less volatility should help you sleep better at night.
1. A low-risk investment
Bonds are considered very low risk, which is quite a perk when markets are extremely volatile. Investments that swing dramatically up or down can be stressful, so a bond’s consistency can help investors sleep better at night.
Or, at least they can encourage investors to stop constantly checking their portfolios in times of crisis.
2. A good fixed income option
Bonds are fairly predictable and provide returns on a fixed schedule.
Their predictability means you can count on them to shoulder the brunt of volatility when needed.
3. Helps diversify your portfolio
Diversity within your portfolio is a huge plus and means you aren’t at the mercy of just one asset class. A more diversified approach is better for safeguarding your hard-earned money during downturns in the market.
For instance, those who are heavily invested in tech stocks might be scrambling right now as everyone heads back to their offices and shopping malls, stepping away from their online shopping habits.
3 downsides of investment bonds in Canada
Of course, there are drawbacks to investing in bonds in Canada, mainly due to the low yields they provide – the bang for your buck is lacking.
1. Not the most liquid investment
You can cash most government bonds any time, but you won’t get the fully matured rate as advertised at the onset. At the same time, other bonds aren’t as liquid and your money remains locked in for the duration.
There’s also the risk of losing money if you sell too soon – so beware when making your investment choices.
2. Unpredictable interest rates
There are 2 types of bonds: long-term bonds and short-term bonds. With long-term bonds, interest rates can cause havoc, causing your investment to earn less in the long run.
On the other hand, shorter-term bonds pay less interest since, as the term suggests, their terms are shorter.
3. Issuer may default
It’s entirely possible that the issuer will default – and your money goes with them.
Pay attention to an issuer’s credit quality – this rating is an indication of how likely they are to default. And, as mentioned, it’s often best to stay away from these higher-yielding, riskier bonds unless you’re a seasoned investor.
Investment bond alternatives
Naturally, there are alternatives to bonds as fixed income assets for investment.
Here are a few alternative examples for you to consider.
| Type of investment | Pros | Cons |
|---|---|---|
| Real estate | * Fewer risks * Tax benefits * Physical asset you can touch and see |
* Requires high initial cash investment * Current housing market is tough * Liquidating depends on market conditions |
| ETFs | * Low risk * Buy a diversified bundle of bonds in one ETF * Low fees * Monthly dividends |
* Boring * Can be risky if going for higher yields * Do your research, not all ETFs are created equally |
| Index funds | * Low risk * Buy a diversified bundle of bonds in one swoop * Low fees * Low volatility |
* Tracking an index can be subject to swings * Boring |
| Mutual funds | * Low risk * Buy a diversified bundle of bonds * Professionally managed |
* Higher fees than ETFs |
| Stocks | * Chance for higher returns * Easily liquidated * Piece of ownership of a company |
* Subject to market conditions * Potentially higher volatility |
Real estate
It’s no secret that we love real estate here in Canada. In fact, Canadians now have more than $2 trillion dollars worth of real estate debt.
As an investment, real estate is a physical, tangible asset. You can touch, feel, and experience it by living in or renting out your property. Its tangible quality makes it particularly appealing to us.
The drawback is that it can be difficult to liquidate if the housing market takes a downturn. Also, prices can drop at any time as demand changes, as some of Canada’s larger cities are now seeing.
ETFs
ETFs are attractive because they offer diversification with low fees – they can be made up of anything, including a combination of stocks and bonds. And high levels of diversification are closely linked to high levels of security.
The downside here is that not all ETFs are created equal. Something like Vanguard’s VGRO can be attractive because it offers a wide breadth of the financial markets, but other ETF options can be more volatile.
So you really need to do your homework and know what you’re purchasing.
Index funds
Index funds offer top-notch diversification since one fund can contain hundreds of individual stocks. This type of investment offers wide exposure and takes a lot less work than choosing stocks one by one.
But since you have no control over the makeup of the index fund you choose, it can be a bit frustrating. And there’s little protection offered in case of a market downturn.
Mutual funds
Mutual funds, like ETFs, offer an affordable entry point to the stock market. They’re also flexible, allowing you to buy, sell, and reinvest as you please.
One big drawback, however, is their higher management fees. You could be looking at fees for sales, annual expenses, and early withdrawal penalties, plus commission for purchasing and redeeming.
Stocks
You don’t need to be a market expert to invest in stocks, don’t always need much money to get started, and there are virtually endless companies offering them, so you’re sure to find something you’re interested in.
But, as the stock market can swing both up and down quite wildly, you’re not guaranteed to earn returns on your investments. And even if you do invest in a quality company and the market’s volatility is reined-in, it can still take years before you see significant returns.
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$25 GeniusCash + Delicious meal choices with fresh ingredients + Front-door delivery.Do you include investment bonds in your portfolio?
Bonds are an important part of the Canadian investment wheel, and you can definitely benefit from adding them to your portfolio.
Do you currently hold any bonds? What are your experiences with bonds in the Canadian market?
We’d love to hear your thoughts and advice on this topic, so feel free to leave us a note in the comment section below.
FAQ
What is a bond?
A bond is best described as a loan between a company or government organization and an investor. The idea is that it pays a fixed interest rate in return for your investment. You can read more about bonds and how they work here.
What is the face value of a bond?
The face value of a bond is the price the issuer pays the investor when the bond matures. Other terms used in place of “face value” are “par value” or just “par.” To learn more about how you can make money with investment bonds, click here.
Can you tell me how to invest in bonds?
You can invest in bonds by working with an online broker. This way, you’ll have the choice to buy bonds directly or as part of an ETF. Another option is to skip the middleman and purchase straight from the government or company issuing the bonds. You’ll find more information on investing in bonds right here.
Is investing in bonds in Canada a good idea?
Having bonds as part of your investment portfolio is a good idea for most investors. Of course, there are pros and cons to every financial decision you make, but bonds are a low-risk choice for most investors. For more pros and cons of investment bonds, click here and here.
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