Federal bonds are in great demand this year because these securities now yield attractive interest rates. Here you will find the answers to the most important questions.
What is a federal or state bond?
States need money to pay their expenses and borrow money from investors through bonds they issue. Government bonds are securitized loans from a country that pay a fixed interest rate, also known as a coupon, to the buyers of the bond (creditors). Interest payments are usually made once a year. In Germany, government bonds are called federal bonds, although the term of government bonds can vary greatly. The amount of interest depends on the term of the government bonds; as a rule, the longer the term, the higher the interest.
Where do I buy government bonds?
Even if a country’s bonds are called government bonds, they are not purchased directly from the government. As is usual with stocks, government bonds and other bonds (fixed-interest securities or bonds) are bought and sold on the stock exchange through a bank or broker. This means that investors only need to set up a securities account at a financial institution and bond trading can begin.
How high are the returns?
In contrast to interest rates, the return on a bond is not fixed. Bonds, like other securities, fluctuate over their lifespan, but generally less so than stocks. Bonds are issued at a price of 100 percent, the so-called nominal or nominal value. Then the coupon and return correspond. After the issue, the securities are traded on the stock exchange and fluctuate depending on supply and demand. If the price of a bond increases, the yield decreases and vice versa. For those who want to invest in bonds during their term, both the purchase and sale prices are crucial for the return.
How long are the terms and how high are the interest rates for government bonds?
The terms of federal or state bonds are often between a few months and 30 years. But there are exceptions; Austria and some other countries have already issued 100-year bonds. At the end of the term, bond buyers receive the face value of the bond back if the issuer, i.e. the country, has not become insolvent. The interest rates are based on the general interest rate level and, in addition to the term, also depend on the creditworthiness of a country.
As is always the case when investing, it is important to note that “higher interest rates usually also mean more risk. The more solvent a debtor is, the less interest he has to offer,” says Jürgen Molnar, analyst at Robo Markets, assessing the opportunity and risk for the interest rate market a. This interest is usually paid out once a year. The yield table for 10-year federal bonds, which are considered very safe, is currently around 2.5 percent, and in the USA, 4.4 percent is currently paid for 10-year government bonds. “Anyone who invests in US bonds should take the currency risk into account. If the dollar rises, currency profits can arise and vice versa,” says Stefan Riße, capital market expert at the fund company Acatis. Government bonds are traded actively, so they have sufficient liquidity and can be sold at any time, even before the actual end of their term.
Yields have fallen recently, is it still worth investing in government bonds?
“Anyone who buys government bonds at the slightly lower level will still achieve an attractive return compared to the zero interest rate phase of recent years,” says Salah Eddine-Bouhmidi from broker IG. Since inflation has also fallen recently, the real return, i.e. the return after deducting inflation, is improving at the same time. It has slipped back into positive territory following the recent decline in inflation.
The most recent price rally on the bond markets in November was one of the strongest months in years, but the previous stock market months were rather mixed. The November rally was driven by hopes that central banks in the USA and Europe would soon cut key interest rates. Interest rates move inversely to the bond price, which is why falling interest rates and yields lead to price gains for bonds. “Investors can see how significant interest rate changes of two or three percent are by looking at a specific 100-year bond issued by the country of Austria. When interest rates were at their lowest in 2020, this bond had a price of 225. With the significant increase in interest rates in Europe, the price has risen to 70 fell,” expert Molnar calculates the sometimes significant price changes.
Are key interest rate cuts expected for 2024?
According to leading central bankers in the USA and the EU, interest rate cuts are at least becoming more likely, which can also be seen on the market. The market there is pricing in the first key interest rate cuts in the USA in May with a probability of almost 80 percent. If key interest rates actually fall next year, government bonds with a longer term will often perform better than those with a shorter one.
Are bond ETFs preferable to investing directly in government bonds?
With a bond ETF, investors invest in several government bonds, meaning they are broadly diversified in the bond sector. In principle, a bond ETF works similarly to a stock ETF. Investors can invest in these securities with a one-off payment or via a savings plan. The opportunity-risk profile compared to an investment in federal bonds essentially depends on the associated government bonds that are bundled in the ETF. When buying a bond ETF, you should also pay attention to the overall costs in addition to the overall creditworthiness. They usually amount to 0.1 to 0.5 percent per year, with the latter brand being seen as expensive. “In addition, investors should find out beforehand which bond maturity a fund refers to, because there can be noticeable differences between short-term bonds and bonds due in 20 to 25 years,” says strategist Risse.
Daniel Saurenz runs the stock market portal Feingold Research.
This article does not constitute a recommendation to buy or sell individual bonds or other financial products. No liability is assumed for the accuracy of the data.