I’ve been a big proponent of investing savings in the S&P 500. It offers great long-term returns, and is safe. But it’s not that safe.
The S&P 500 isn’t the safest investment because when you buy equity/shares in a publicly traded company, you are buying a slice of ownership. Your fortunes rise and fall with the fortunes of the company you partly own. And you can sell your shares the same way people sell barrels of oil or any other commodity, through a market.
But if the company you partially own goes bankrupt, chances are, you’ll end up with nothing. That’s because a long line of people and organizations that the bankrupt organization owes money to are first when it comes time to cash in on whatever is left of the company. This includes banks, employee wages and bond holders. Share holders are usually last to get any pay outs in the event of a bankruptcy, and usually get nothing.
Bonds are basically IOUs that a large government or company will issue. They are cheap loans that a government can make because all western governments are so large and have been around for hundreds of years, that they can guarantee your return.
A bond is a financial certificate, it means the bank owes you money. But it also means you have no say in any of the banks matters, unlike a share holder. So bonds are creditor stakes in a company, whereas share holders have equity stake in a company. When a company goes bankrupt, creditor stake holders will have priority over equity stake holders when it comes time to dividing the remains.
Western countries are basically impervious to bankruptcy for the foreseeable future. Even though headlines can be grim, and all governments take on more and more debt, there has also been an increase in Gross Domestic Product (GDP). If you totaled the value of every financial transaction in Canada, every exchange in goods or services for money, you would have the gross domestic product. In 2014, Canada’s GDP was $1.8 trillion USD.
Of that $1.8 trillion, the Canadian Federal Government took $276.3 billion in taxes and other revenue. With that kind of growing revenue, it is easy to be convinced that a large government can guarantee the bonds that it issues.
Bonds are usually sold at specific times, in Canada, Canadian Savings Bonds (CSBs) are sold every October and November. They have a 10 year maturity. That means that you get the money back on your bonds after 10 years. You get your interest payments once a year.
Bonds backed by most western governments are so safe, they are considered to be risk-free. As such, they offer a low interest rate of return tied to the interest rates set by the Bank Of Canada. The annual returns for the CSB can be found online here. As you can see from its previous returns, bonds don’t make you a lot of money. In 2014, Canadian Savings Bonds would yield only 1% per year, it would be easier to just get a high interest savings account in 2014.
Bonds are something that you can buy through various Exchange Traded Funds (ETFs), but you can also buy them yourself directly through the government every October. For more information on buying Canadian bonds directly, information can be found on their website.