Is Investing in Government Bonds a Good Idea? (Pros & Cons)

We live in an uncertain world. It's always uncertain, but it seems to be particularly uncertain at the moment, ever since the pandemic struck.

As a result, some investors look to government bonds as a haven for their money. Others think it's time to move from government bonds entirely and invest elsewhere. So who is right? Here are some pros and cons of investing in government bonds

Advantages of Investing in Government Bonds

There are several good returns that you can reap by investing in government bonds. Here are some of the benefits you can get:

Offers Secure Investments

The most significant risk in investing in debt securities such as bonds is the possibility of the entity that issued the bond defaulting on its obligations to the bondholder. If, say, company X defaults on its corporate bond, you will no longer receive interest payments or the bond's maturity payout. 

Unlike other types of bonds, governments give a more secure option - they are generally considered low- to risk-free investments. It is very unlikely for a government to default on a bond. On the other hand, corporations can – and they do – file for bankruptcy and default. 

Public Good

Some investors would prefer the concept of their money supporting government initiatives rather than a for-profit company. 

For example, the government's M-Akiba infrastructure retail bond allows investors to save their money where they can see it at work and at the same time earn an attractive interest rate of 10%.

M-Akiba seeks to enhance financial inclusion for economic development - funds raised are used to support new and existing government infrastructural development projects.

Offers Tax Benefits

In Kenya, infrastructure bonds which the government uses to invest in infrastructure projects are popular among investors because they are tax exempt. The returns from tax-free bonds are more than from taxable treasury bonds. 

Has an Easy Exit Alternative

A treasury bond is a real asset that you can trade in the Nairobi Securities Exchange (NSE) similar to company stocks. This gives a treasury bondholder the ability to receive money for their security without having to rediscount. 

Rediscounting is the other exit alternative when you want to redeem your security before the maturity date. The CBK will buy back the security but at a punitive rate to discourage such a practice. 

Unlike other less liquid investments such as real estate, whenever you want to come off this investment, you will only need to put your bonds up for sale, and that's it, you’re out.

For instance, in the first quarter of 2021, as the effects of Covid-19 ravaged the country, the volume of bonds traded at the NSE far surpassed stocks as investors continued to seek safety in fixed income assets as opposed to the volatile stock market. 

Bonds traded between January and March 2021 increased 33% to Ksh199.4 billion as compared to a 27% reduction in equities traded to Ksh31.8 billion, compared to the same period in 2020. 

Not that treasury bills cannot be traded at the NSE. 

Provides Regular Income

Government securities give you a profit and a steady income stream over a set length of time. Investors who purchase these securities are making a loan to the country, which pledges to reimburse them after a set length of time, known as maturity. 

In most cases, you will receive your returns in terms of interest after every six months. However, the intervals might vary depending on your signed agreement. The assurance is that, before your investment matures, you will be receiving your interest whether or not the government sustains losses. You can therefore budget with this income since it's consistent and reliable.

Every month, there are auctions for treasury bonds that occur. With such an opportunity, you can build a portfolio that allows you to earn monthly interest.

Offers a Sound Investment Plan for Long-Term Objectives

Some bonds have a more extended maturity period which can go up to 30 years. Considering its long duration, you can use such investments to cater for your prolonged objectives like retirement, your children's higher education, or any other plan that could be feasible to you.

The Disadvantages of Investing in Government Bonds

While bonds are deemed to be risk-free and ideally then they should be very attractive, they may not be necessarily the best investment option for all needs. 

High Trading Amount

Bonds in Kenya are bought and traded in multiples of Ksh50,000. It, therefore, means that this is the minimum amount you can put up for any purchase or sale. You will have to put down either Ksh50k, Ksh100k, Ksh150k, and so on to be eligible to purchase or sell a bond.

This may be disadvantageous for a beginner investor who cannot raise such an amount at a go. But, it also could be great for someone investing for a longer-term objective and would benefit from the assured higher returns of investing a large amount from the get go. 

No Capital-Protection

Bonds issued by the Treasury do not have capital protection. It implies that their value on the NSE might fluctuate, and if you trade your bond before it matures and the price has dropped, you might get lower than your investment. Therefore, you will need to exercise prudent timing to make your sals as far as possible if you are to make more gains.

Who Can Invest in Government Bonds?

According to the Central Bank of Kenya, anyone can invest in Treasury bonds through the Central Bank despite the fact that commercial banks, business entities and pension funds are among the biggest investors in government bonds.

If you want to invest in government securities, you'll need a bank account with a local commercial bank and a CDS account with the Central Bank. Kenyans and international investors who meet these requirements can invest freely with the Central Bank in government securities.

Individuals who do not want to form a CDS account with the Central Bank could still invest by establishing a client account with a commercial bank, which will invest in their place. While it is free to open a CDS account, commercial banks often charge fees for client accounts.

Kenyans residing abroad who have a valid Kenyan bank account are eligible investors in government securities. They could create a CDS account and send the Central Bank any relevant forms via email.

You can get more details on how to invest in bonds here.

Conclusion 

Government bonds offer a great investment opportunity for all. Like every other investment, it has its advantages and disadvantages. Depending on the reasons for your investment, it may or may not be the right option for you. If you are unsure of whether government bonds are for you, you may want to speak with an investment advisor to better weigh your options.