When we talk about investing in equity, usually the investment time frame accompanies the discussion. Whether you invest in large caps, mid-caps or small caps, the consensus is that investing in equity requires time and patience. The long term time frame may not have an end date but ideally, investing in equity means holding on for at least five years.
When it comes to investing in bonds, there is no specific time frame you can decide from the start. Unlike equity stocks, which have a shelf life of their own, bonds come with a specified maturity period.
At the completion of this tenure, bondholders are repaid their principal amount along with any interest overdue. The good news is that bonds are issued with varying tenures and there is a secondary market hosted on stock exchanges where you can get an early exit too.
To decide the time frame for your bond investment, you must first earmark the goal attached to it.
Hold till maturity
As mentioned above, bonds are issued for varying tenures. For example, a recent public issue for non-convertible debentures (debentures are bonds) issued by Edelweiss Financial Service Ltd, the tenures ranged from 24 months to 120 months, across ten different series. The four distinct tenures available were 24 months, 36 months, 60 months and 120 months.
If you plan to invest in a bond, you must decide whether it is to take advantage of the coupon being offered or if it is to cater to a specific goal over time. In the case of the latter, it’s easy to pick the tenure you want to match your goal with.
For example, let’s say you have to pay for your child’s higher education in 5 years and want to cater to that goal with 50% in equity and 50% in debt. Within the debt allocation, you can pick a bond maturing in 5 years and remain invested till you get your principal back at the end of the tenure.
If it’s the former, getting a good return on your debt allocation, then taking minimum tenure is the best way.
Locking in for 10 years does not make sense, because interest rates fluctuate over time and by locking in a long tenure you miss out on the opportunity to potentially upgrade the return you can get.
Secondary market investment
You can also buy and sell bonds in the secondary market. In this case, a time frame attached to goals may not be the most optimum way to decide your investment tenure.
Bonds listed in the secondary market see a fair amount of fluctuation in their daily prices, hence, this is not a suitable investment if the safety of capital is your priority. For capital protection, applying to a public issue and holding till maturity is a better strategy.
When it comes to investing through the secondary market, your investment time frame may be dictated more by the interest rate cycle in the economy than your goal. The goal in this case usually is to maximise return.
When interest rates in the economy are headed lower, bond prices start to move up and this is a good time to hold your investment. When the opposite happens and the rate cycle starts to move up, you will see bond prices moving down, it is best to sell or hold back on buying at this point in time.
Be warned that interest rate cycles are difficult to predict and can last for months or years at a time.
Defining a time frame for a secondary market investment strategy in bonds is a high-risk proposition if you are doing it unassisted. In summary, use good quality bonds for specific goals and match your tenure with the remaining maturity period of the bond, hold till the end and benefit from the stable income.
For return maximisation, you may want to go the secondary market route and match from time frame with the interest rate cycle, but that is fraught with risks and best attempted with an advisor by your side.