Who is investing in bonds a good fit for?

Quick Overview

Bonds may be particularly suitable for investors who:

• have built up a financial reserve and won’t need the money anytime soon,
• prefer regular returns over rapid investment growth,
• wants to diversify and balance their investment portfolio,
• understand the risks associated with a specific issuer and the terms of the bond issue,
• do not invest the majority of their savings in a single bond or a single company.

Conversely, they may not be suitable for someone who expects a guaranteed return, needs to have their money available at any time, or is unable to assess the issuer’s financial situation. A corporate bond is not the same as a bank deposit and is not covered by deposit insurance.

Are you considering a specific corporate bond? Before signing or sending any money, have the terms of issue, the type of collateral, and the enforcement options reviewed. Our lawyers will review the documentation for you.

Why Bonds?

Bonds are among the oldest and most popular forms of investment. At their core, they are a loan that an investor provides to the issuer—that is, a government, municipality, bank, or private company. In return for this loan, the investor receives regular interest payments, and the principal is repaid upon maturity. Thanks to this structure, bonds are often considered a more conservative form of investment than stocks, where returns depend on the company’s performance and stock market fluctuations.

For many investors, bonds are a symbol of stability and predictability. Unlike stocks or cryptocurrencies, which can fluctuate dramatically in value over a short period, with bonds you usually know exactly how much you’ll receive and when. However, this does not mean they are completely risk-free. Particularly with corporate bonds, a situation may arise where the issuer fails to meet its obligations.

Investing in bonds is therefore particularly suitable for those who want to diversify their portfolio, protect part of their savings from uncertainty, and at the same time earn a stable income in the form of interest. At the same time, it is an investment tool used not only by small savers but also by large institutions. If you’re deciding whether to invest your money in bonds, let’s take a look at the main advantages and disadvantages of this type of investment.

What Rules Apply to Bonds

The issuance of bonds and their basic requirements are primarily governed by the Bonds Act. The rights and obligations of the issuer and the bondholder are further based on the terms and conditions of the issue and the general provisions of the Civil Code.

For certain public offerings, the issuer must publish a prospectus in accordance with the European Prospectus Regulation. However, even a prospectus approved by the Czech National Bank does not mean that the CNB has verified the issuer’s financial condition or guaranteed repayment of the investment. When approving a prospectus, the CNB primarily checks the completeness, clarity, and consistency of the information provided.

If the issuer becomes insolvent, the investor generally acts as a creditor and must file a claim in the insolvency proceedings. The portion of the claim that will actually be repaid depends on the debtor’s assets, the priority of the claim, and the quality of the agreed-upon collateral.

Advantages of Investing in Bonds

The biggest appeal of bonds is their predictability. Most issues have a fixed interest rate, which is paid, for example, once a year or semiannually. This allows investors to plan their cash flow with a high degree of certainty. This is a huge advantage, for example, for people who want a regular income in addition to their retirement or supplemental pension.

Another major advantage is lower risk compared to stocks or other volatile assets. While stock prices can fluctuate by tens of percent in a short period of time, the value of a bond is more stable. Moreover, with government bonds, there is virtually zero risk of default. This is because the government has various ways to raise funds, such as by increasing taxes.

Bonds also play a key role in portfolio diversification. If an investor has part of their savings in stocks or mutual funds, bonds can provide a stable counterbalance. When stock markets decline, bond yields can help ensure that the overall value of the portfolio does not fluctuate as significantly.

Last but not least, it’s worth mentioning special types of bonds, such as inflation-indexed bonds, which can protect the real value of money. These bonds have become very popular in the Czech Republic, especially during periods of high inflation, when regular savings accounts couldn’t keep up.

Disadvantages of Investing in Bonds

Although bonds are often referred to as a safe haven, it’s important to recognize their limitations as well. The most obvious disadvantage is lower returns. If an investor is looking for high returns, bonds are likely not the right choice. Yields on government bonds are usually only a few percentage points above inflation, which is less than what you’d get from more dynamic investments.

A major risk, especially with corporate bonds, is default. Smaller or start-up companies often attract investors with high interest rates, sometimes even exceeding 8–10% per year. But that is precisely where the greatest danger lies. If the company fails, the investor could lose their money. In the past, there have been several bond issues in the Czech Republic where creditors never saw their money returned.

Another pitfall is inflation. With fixed interest rates, a situation may arise where inflation significantly outpaces the bond’s yield. Although the investor receives the promised interest, their real purchasing power declines. This is one of the main reasons why it is recommended today to diversify investments and not rely solely on a single asset class.

Limited liquidity is also a common drawback. While stocks can usually be sold on the stock exchange within a single day, a bond may not have a secondary market. As a result, investors are often forced to hold it until maturity. And even if an investor does manage to sell a bond, it may only be at a significant loss.

How to Choose the Right Bond?

Choosing the right bond is therefore a crucial step. The key factor is the issuer —that is, who is issuing the bond. Generally speaking, the more stable and trustworthy the issuer, the lower the risk. Governments and large banks are more reliable than small or newly established companies.

It’s also important to consider the interest rate and maturity date. A high interest rate may seem attractive, but it often means higher risk. Conversely, an excessively long maturity date can be disadvantageous when the economic situation changes. Investors should also check whether the bond offers an early redemption option or whether it is tradable on an exchange.

Another factor is the credit rating—a numerical or letter-based assessment that indicates how likely the issuer is to meet its obligations. For large issuances, ratings are issued by international rating agencies, which assess the issuer’s ability to meet its obligations. Even if smaller issuances do not have a rating, it is worth at least monitoring the company’s financial results and history.

The collateral securing the bond also plays a major role. Some bonds are backed by assets or guarantees, while others are not. A secured bond reduces the risk that an investor will lose all of their funds, even if the company goes bankrupt.

A prudent investor should always compare several offers and avoid making hasty decisions. If unsure, it is advisable to consult an expert —such as a lawyer or financial advisor.

In practice, we encounter investors who focused primarily on the promised interest rate but failed to verify the company’s financial situation or the actual value of the collateral. It was only upon the first default that they discovered the issuer had multiple creditors, the assets were encumbered by prior liens, and the bond could not simply be sold.

The most common mistake is the assumption that a high interest rate is an advantage without corresponding risk, or that the Czech National Bank’s approval of the prospectus confirms the issuer’s reliability. In reality, investors must independently assess the company’s ability to repay the debt.

Checklist: What to Verify Before Signing

Before sending any money, be sure to check the following in particular:

1. Who is the issuer: How long has it been in existence, who owns it, and who actually manages it?
2. Financial results: Does the company publish financial statements, and does it have sufficient revenue to repay both interest and principal?
3. Purpose of the offering: Is it clearly explained what the money will be used for?
4. Total debt: Is the company issuing multiple bonds at the same time, and does it have other significant loans?
5. Terms of the issuance: When is the principal due, under what circumstances can the issuer defer payments, and can it redeem the bond early?
6. Collateral: Is there truly valuable collateral, and does the investor have a mechanism available to enforce it?
7. Subordination of the claim: Will other creditors be paid first in the event of bankruptcy?
8. Liquidity: Can the bond realistically be sold before maturity, or can it only be transferred in theory?
9. Role of the seller: Does the person recommending the investment receive a commission?
10. Prospectus: If it has been approved by the Czech National Bank (ČNB), keep in mind that this does not constitute a guarantee of the safety or return on the investment.

From our experience: An investor put their savings into corporate bonds that were presented in promotional materials as being secured by real estate. However, after insolvency proceedings began, the investor discovered that the real estate was already encumbered by the claims of other creditors and that its sale value did not cover all of the company’s debts.

The word “secured” alone is therefore not enough. Before investing, it is necessary to verify the priority of the security interest, its fair market value, the existence of other creditors, and the exact procedure by which investors’ rights will be enforced.

Has the issuer stopped paying interest or failed to repay the principal on the due date? Don’t wait to take action. We’ll review the terms of the issuance, prepare a pre-litigation demand, and recommend the next steps, including filing a claim in the insolvency proceedings.

Who are bonds suitable for?

Bonds are not a one-size-fits-all solution for everyone. They are best suited for conservative investors who seek stability and want the assurance that they are highly unlikely to lose their money. They are often used by people who already have a secure income and do not need high returns, but rather a reliable source of income to cover their living expenses.

They are also highly suitable for retirees or people approaching retirement age who appreciate a regular income from interest. They are also a good option for parents or grandparents who want to save for their children or grandchildren over the long term. The stable and predictable returns allow them to plan for the future.

Bonds are also worthwhile as part of portfolio diversification. A dynamic investor who already has some money in stocks or mutual funds can use bonds to reduce the overall risk of their portfolio.

On the other hand, bonds aren’t ideal for investors seeking rapid capital growth. If your goal is high returns and you’re comfortable with risk, you’re more likely to opt for stocks, mutual funds, or alternative investments.

Summary

Bonds can be a suitable component of a portfolio for an investor seeking regular income, who has sufficient financial reserves, and who is able to keep the money invested until maturity. However, safety is not determined by the name of the investment, but primarily by the issuer’s creditworthiness, its debt levels, the terms of the issue, the quality of the collateral, and the ability to sell the bond early. A higher interest rate usually also means higher risk, and investments in corporate bonds are not insured. Therefore, before purchasing, always research the issuer, review all documentation, and do not invest a significant portion of your savings in a single issue.