The U.S. National Association of Securities Dealers found in a survey that individual investors have such a poor understanding of bonds that it felt something had to be done. So it recently launched a special educational website, called Smart Bond Investing.
While the new online learning centre for bonds (see www.nasd.com) is designed for American investors, it would also be a good place to start for Canadian investors, who are likely no different in their limited understanding of the bond market.
A quick review of one of Canada’s top investor learning sites, www.investorED.ca, which is sponsored by the Ontario Securities Commission, turned up virtually no information on bonds other than a few definitions in the glossary.
The NASD-sponsored survey of close to 1,100 investors, aged 21 to 69 and who performed at least one stock, bond or mutual fund transaction in the preceding six months, turned up a surprisingly low level of investment literacy.
While 71 per cent understood the concept of a bond and an even higher 84 per cent identified U.S. Treasury bonds as the safest, only 40 per cent understood the relationship between bond prices and interest rates.
About half (51 per cent) knew the definition of a “junk bond” (a bond rated below investment grade by rating agencies).
Also, 34 per cent either thought there is no fee for buying or selling a bond or they did not know whether they were paying a fee for bond transactions.
The last statistic is not surprising because in the United States, much like in Canada, securities dealers do not have to disclose the mark-up they charge on bonds bought or sold with individual investors.
Unlike with stock transactions, there is no indication of bond commissions on the confirmation slips that dealers mail out to the account holder, as dealers so far are only obligated to record the final price paid and the yield.
As a result, most investors assume there isn’t a commission involved, but there definitely is and it sometimes can be substantial. The usual commission is 1 per cent of face value. For example, the mark-up on a purchase of $50,000 face value of bonds would be $500. But investment advisors have been known to take more, since they know their clients won’t be informed how much on the confirmation slip.
To its credit, the NASD Smart Bond Investing website openly discusses commissions and how they work and advises investors to be fully informed by asking what commissions or mark-ups are involved in any bond transaction.
In announcing the new site, which is a follow-through on its motto that “the most potent form of investor protection is investor education,” NASD stated that “there’s no doubt that retail investors need to be armed with more information and better education about bonds and bond investing.
“Bond investing is an important diversification strategy and can be used to accomplish a variety of investment objectives. But investors should recognize that like all investments, bonds and bond mutual funds carry risk.”
The Smart Bond Investing website aims to untangle the complexities by offering concise information about bonds and bond funds as well as tips and strategies for investing. It demystifies coupon rates, call risk, yield to worst, TIPs and STRIPS, and covers investment strategies such as bond ladders.
Special features include a ‘risk report card and snapshot’ for corporate, municipal, government and additional types of bonds, an interactive ‘accrued interest calculator’, a bond and bond fund comparison table, and a ‘top 10 list’ of things to consider before investing in bonds or bond funds.
The website also provides access to real-time daily corporate bond pricing data – something Canadians may find valuable if they begin to invest in U.S. corporate bonds, which currently offer higher yields than comparable Canadian corporate bonds, once the foreign-investment limits are lifted upon the successful passage of the federal budget.
The NASD, which is a capital markets regulator overseeing the activities of 5,100 brokerage firms and 660,000 registered securities representatives in the United States, has a role similar to the Investment Dealers Association in Canada.
Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.
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©2005 Wayne Cheveldayoff