Have you ever had to borrow money?
If you have not seen yourself in the situation, surely you know someone who has. Loans are one of the most common parts of society and it is a situation that some other company has also had to go through. Even the government does. Do you know how? Issuing government bonds. In this article, we tell you everything you need to know about investing in government bonds, in case you have considered doing so or if you would like to try it in the future.
When the State issues a bond, it requests a certain investment of money. It then promises to pay back that investment, plus interest, over a specified period. Here, we’ll dive into the world of bond investing so you can determine if they should have a place in your investment portfolio. Although as many experts advise, diversifying the investment is the best option for savers, which is why many complement their investment in government bonds with bank deposits.
What are government bonds?
When the Government decides to issue State bonds, it does so to finance the public deficit. These bonds are long-term securities issued by the Government for this purpose. When you buy a bond, you are lending a sum of money to the government for a predetermined period. In exchange, the state agrees to make regular interest payments at a predetermined rate until the bond matures, and then repay its principal upon maturity.
For example, suppose you decide to buy a government bond of 10,000 euros for 10 years with an interest of 3%. The Government, in return, will agree to pay you interest on those 10,000 euros every six months, and then return the 10,000 euros when the 10 years have passed.
There are exceptions, of course, such as zero-coupon bonds. Interest is not paid on those, but they are sold below face value. However, most government bonds follow the same formula: you invest a sum of money, collect interest, and get your money back at maturity.
Government Bonds or Treasury Bills?
Some people confuse government bonds with Treasury bills. The difference between one and the other is mainly the date of issue of each of them. So the fact of investing in one or the other will depend mainly on the term you want to give yourself to recover the investment made.
- Treasury Bills: Mainly for issues of less than 18-month terms. To do this, what is done is to use the discount formula whereby what is done is to buy the Treasury bill, minus the applicable interest rate, so that when it expires, the full amount of what was invested is returned.
- Government Bonds: On the opposite side are the Government bonds. Its issue term is greater than 18 months. When you are going to buy, what you do is that you pay the amount or part of it and you receive payments regularly, which can be quarterly, semi-annually, or annually. So when the term expires, the face value is returned, plus the last corresponding coupon.
Before deciding whether to invest in treasury bills or government bonds, it must be taken into account that the preferred investment product for Spaniards, given the security it provides, is bank deposits. Investing, for example, in treasury bills is usually more profitable when the public coffers are experiencing financial difficulties, which is why periods of crisis are the most advantageous for this type of investment, while deposits, as can be seen on the Raisin website, they ensure constant profitability.
Benefits of investing in government bonds
safe investment
An advantage of putting government bonds in your portfolio is that they are a relatively safe investment, although not so much when compared to depositing the money in bank deposits. Bond values don’t tend to fluctuate as much as stock prices, so you’re less likely to worry about their potential fluctuations in value. Although if what you are looking for is security, the most appropriate option is to bet on savings accounts or long-term bank deposits.
Predictable income stream
Another benefit of bonuses is that they offer a predictable stream of income. Because bonds pay a fixed amount of interest twice a year, you can generally trust that money to come in as expected. Government bonds and Treasury bills offer the added benefit of paying interest that is tax-exempt to varying degrees.
An investment in society
On top of that, some investors like municipal bonds because they offer the opportunity to invest in the company. When you invest in a government bond, you can help improve a local school system, build a hospital, or develop a public garden. It’s that social angle, combined with the potential for completely tax-free interest income, that makes some investors forgo the higher interest rates of other corporate bonds and invest in government bonds.