How to make 1-2% more money on bonds than on a deposit

If you have decided that free money should generate income, then it is not necessary to choose a deposit as the easiest type of investment. Bonds can yield higher interest rates with relatively low risk.

So, now deposits bring on average 6-7.5% per annum, which, in principle, is already quite good. But why not get more?

What are bonds and what is their advantage?

Bonds are debt securities, the holder of which receives interest payments (coupons) and the principal body of the debt (bond par value) upon maturity.

Bonds, unlike deposits, can be bought and sold on the stock market. For example, if you wanted to buy stocks instead of bonds, then you can immediately sell bonds to transfer money to other instruments.

Bonds of issuers with a high rating are comparable in terms of reliability to deposits. If the bonds are government bonds, then the state acts as the guarantor of coupon and par value payments. If the bonds are corporate, then large reliable banks or large stable companies are borrowers.

What are types of bonds?

Several types of bonds are available to the investor on the market. Using the example of Russian Federation, we can point out:

• Government bonds (OFZ – Federal Loan Bonds): yield rate ~ 6.5–8% per annum, depending on the maturity date.
• Sub-federal bonds – bonds of individual constituent entities of the Russian Federation. Subjects borrow money, for example, to finance projects on their own or to pay off budget deficits. The rate of return is usually 1-2% per annum higher than the OFZ rates.

These bonds are also more risk-free. For example, bonds of the Ministry of Finance of the Krasnodar Territory can sometimes yield higher than the deposit. If you believe that the Krasnodar Territory will not go bankrupt in the near future, then it is logical to buy these bonds and receive a profitable yield.

• Corporate bonds are bonds issued by companies. Even the largest corporations are more risky borrowers than the state, so the profitability and risk for them are slightly higher (by 2-3% for large companies).

Bonds of Gazprom, Rosneft, VTB and other Russian companies are corporate. The names of these companies are the guarantor of the payment of the debt.

• High Yield Bonds are bonds issued by small, less known companies with low credit ratings. The yields on such bonds can reach double digits and significantly exceed the key rate in the economy.

Such companies have a low credit rating, which means an increased risk of default. 

High yield bonds are rated no higher than BB. Statistically, one in four or six of these companies goes bankrupt and will not pay off the debt. You can look at the list of defaulters in an open source and understand which bonds of which companies should not be bought.

There are also foreign currency bonds (for example, Rus-28 – Eurobonds of the Ministry of Finance). The yield in dollars is ~ 50-70% higher than the foreign currency deposit.

How to build a portfolio of bonds?

Before assembling a portfolio of bonds, it is worth deciding on your individual risk / return preferences.

Investors usually prefer to build a portfolio of government, subfederal and audited corporate bonds. High-yield bonds can be added to the portfolio, but you need to understand that one in five companies within a year or two may go bankrupt and not pay off the debt.

In total, if the portfolio consists of 60% OFZ, 30% of corporate bonds of 5 or even 10 issuers (remember about diversification), and 10% is left for risky high-yield bonds, then you can get a yield of 1-2% higher.

A well-designed portfolio of bonds can, with low risk, generate a yield higher than the average deposit rate in a reliable bank.