What you need to know about government bonds
German government bonds are in high demand this year because these securities are now yielding attractive interest rates. Here you will find the answers to the most important questions.
What is a federal or government bond?
States need money to pay their expenses and borrow money from investors by issuing bonds. 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, whereby the term of government bonds can vary greatly. The amount of interest depends roughly 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 bought directly from the government. As is usual with shares, government bonds and other bonds (fixed-interest securities or bonds) are bought and sold on the stock exchange via a bank or broker. This means that investors only need to set up a securities account with a financial institution and bond trading can begin.
How high are the yields?
Unlike interest, the yield on a bond is not fixed. Like other securities, bonds fluctuate during their term, but generally less than shares, for example. Bonds are issued at a price of 100 percent, the so-called nominal or face value. The coupon and yield then correspond. After issue, the securities are traded on the stock exchange and fluctuate depending on supply and demand. If the price of a bond rises, the yield decreases and vice versa. For those who want to invest in bonds during their term, both the purchase and sale price are decisive for the yield.
How long are the maturities and how high are the interest rates on government bonds?
The maturities of federal or government bonds are often between a few months and 30 years. But there are exceptions: Austria and some other countries have also issued 100-year bonds. At the end of the term, the bond buyers receive the nominal value of the bond back if the issuer, i.e. the country, has not become insolvent. Interest rates are based on the general interest rate level and depend not only on the term but also on a country's credit rating.
As always when investing money, however, it is important to note that "higher interest rates usually also mean more risk. The more solvent a borrower is, the less interest they have to offer," says Jürgen Molnar, analyst at Robo Markets, classifying opportunity and risk for the interest rate market. It is precisely this interest that is usually paid out once a year. Around 2.5 percent is currently on the yield table for 10-year German government bonds, which are considered very safe, and 4.4 percent is currently being paid for 10-year government bonds in the USA. "However, anyone investing in US bonds should be aware of the currency risk. If the dollar rises, currency gains can arise and vice versa," says Stefan Riße, capital market expert at the fund company Acatis. Government bonds are actively traded, so they have sufficient liquidity and can be sold at any time, even before the actual maturity date.
Yields have fallen recently, is it still worth investing in government bonds?
"If you buy government bonds at the slightly lower level, you can still achieve an attractive return compared to the zero interest rate phase of recent years," says Salah Eddine-Bouhmidi from broker IG. As inflation has also fallen recently, the real yield, i.e. the yield after deducting inflation, is improving at the same time. It has slipped back into positive territory following the recent fall in inflation.
Although the most recent price rally on the bond markets in November was one of the strongest months in years, the previous months on the stock markets were rather mixed. The November rally was driven by hopes that the central banks in the USA and Europe would soon cut key interest rates. Interest rates move inversely to bond prices, which is why falling interest rates and yields lead to gains in bond prices. "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. At the low interest rate in 2020, this bond had a market value of 225. With the significant rise in interest rates in Europe, the price has fallen to 70," says expert Molnar, calculating the sometimes significant price changes.
Are interest rate cuts to be expected in 2024?
Interest rate cuts are at least becoming more likely following statements by leading central bankers in the USA and the EU, which is also reflected in the market. The market is pricing in the first interest rate cut in the US in May with a probability of just under 80%. If key interest rates are actually cut next year, government bonds with a longer term often perform better than those with a shorter term.
Are bond ETFs preferable to a direct investment in government bonds?
With a bond ETF, investors invest in several government bonds and are therefore broadly diversified in the bond sector. In principle, a bond ETF works in a similar way to an equity ETF. Investors can invest in these securities with a one-off payment or via a savings plan. The risk/reward profile compared to an investment in German government bonds essentially depends on the corresponding government bonds that are bundled in the ETF. When buying a bond ETF, attention should be paid not only to the overall credit rating but also to the total costs. These usually amount to 0.1 to 0.5 percent per year, with the latter mark being considered expensive. "In addition, investors should find out beforehand which bond maturity a fund refers to, as there can be noticeable differences between short-term bonds and bonds maturing 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.
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Investors might find attractive interest rates on government bonds, such as German federal bonds, enticing for their investment, considering the yields. These interest payments are often made annually on securitized loans from a country, like Germany, to its creditors.
By investing in government bonds, individuals do not purchase securities directly from the government, instead relying on financial institutions or brokers to facilitate the buying and selling process on the stock exchange.
Source: www.ntv.de
