Level: Intermediate

Debt investments: an introduction

You’ll notice that many of Rest’s investment options include debt as one of the asset classes. But don’t worry, we’re not saying Rest is in debt, but rather we are investing in debt. So, what are ‘debt investments’ and how can they help your super?
An hourglass

Also known as ‘fixed income’, ‘fixed interest’ or ‘bonds’, debt investments are one of the most popular investment products. In fact, while many are familiar with the global share market and how large it is, the global bond market is actually even bigger!

Despite fixed income being such a common investment, people are often less familiar with debt investments than they are with share or property markets. However, the basics of debt investments aren’t as complicated as you might think. 

Here are the key points we cover in this article:

How do debt investments work?

A typical debt investment follows the same process as when you take out a loan or mortgage at the bank. Except that when you invest in ‘debt’, you are in the power seat as the lender rather than being the borrower.

As an investor in debt, you make a loan to a company or even a government (the borrower). This is typically for a set term, just like you have with a mortgage (e.g. 10 years) and the total loan amount is known as the principal

In exchange for the loan, the borrower must make regular interest payments to you and return the principal at the end of the term of the loan.

The image below shows how an interest-only loan or mortgage works which is similar to how bonds typically operate.

How does a loan work?

A graph explaining how a loan works A graph explaining how a loan works

So how exactly is a bond like a loan then?

Bonds are one of the most common types of debt investments. That’s why you’ll often hear people flip between terms like fixed income, bonds and debt investments.

A bond is a type of loan that a company or government will ‘sell’ or issue when they need to raise funding.

As an example, the Queensland Government may issue a $2.5 billion, 10-year bond to raise money for an infrastructure project like a new highway (please note this example is for illustrative purposes only). In this example:

  • The bond is paying an interest rate (also called a coupon rate) to investors of 4.50% which is paid annually.

  • Rest invests $10 million in that bond, and so are providing the Queensland Government with a loan for 10 years.

  • There will be other investors also investing into that same bond with Rest, as the Queensland Government is looking to raise $2.5 billion.
An infographic explaining how a bond is like a loan An infographic explaining how a bond is like a loan
  • In exchange for that loan, the Queensland Government will make regular annual interest / coupon payments to Rest at a rate of 4.50% per annum.

  • After 10 years, the Queensland Government will repay the principal to investors (i.e. Rest receives back its initial $10 million investment). 

Payment schedule for Rest’s investment in a Queensland Government bond

Infographic illustrating the payment schedule for Rest’s investment in a Queensland Government bond Infographic illustrating the payment schedule for Rest’s investment in a Queensland Government bond

A defensive investment, with regular income

Debt investments can play an important role in a diversified portfolio, with several key benefits:

  • Regular income – debt investments typically offer a steady and generally more predictable stream of income through interest / coupon payments.

  • Preservation of your initial investment - unlike many other types of investments (i.e. shares or property), the borrower must repay the original investment (or principal) to the investor at the end of the term of the loan.

  • Diversification – Bonds are ‘defensive’ which means they are typically less volatile than growth investments like shares. That’s why debt investments can be appealing from a diversification standpoint as they may balance out portfolio performance, smoothing the ups and downs of other asset classes like shares.

  • Liquidity – the global bond market is huge with many investors buying and selling bonds. That means that if you need to adjust your investment portfolio, it is generally easy to find a buyer for your bonds and convert debt investments into cash.

Investment risks

All investments carry risk and debt investments are no different. It’s important to remember though that debt investments are considered defensive and therefore lower risk. So, while they offer many benefits, they do typically provide lower returns than other riskier investments like shares, alternatives, infrastructure or property. While debt investments are considered to be a less risky form of investment they are still subject to risks including credit risk – the risk that the borrower fails to pay, and interest rate risk – the risk that higher interest rates will decrease the value of debt investments issued with a lower interest rate . 

Debt investments at Rest

At Rest, we believe that debt investments play an important role in a diversified portfolio. Debt investments are typically defensive in nature and perform better during periods of share market volatility. By diversifying our portfolios to include debt investments, it can help to smooth out more the volatile assets classes like shares while also providing investors with a regular source of income. That’s why debt investments align well with our focus on delivering superior, long term returns for our members.

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