To keep it simple, let's look first at a bond with a fixed interest rate. You need to know three things:
- What you paid for the bond.
- How long until it matures.
- The interest rate.
Example: Let's say you decide to invest $5,000 in a 10-year Government of Canada bond. The bond pays 4% interest a year. If you hold the bond until it matures:
- You'll get back the $5,000 you started with.
- Plus, you'll get back 4%, or $200, a year.
That means your total gain will be about $2,000 over 10 years ($200 x 10).
Tip: When you reinvest your interest each year instead of spending it, your investment grows faster. This is called compounding. In the example of the 10-year government bond, if you reinvested the 4% interest each year, after 10 years you'd have almost $500 more.
What will I make on bonds with floating interest rates?
Floating interest bonds follow the interest rate on three-month treasury bills (T-bills). They pay interest four times a year (quarterly). If the T-bill rate goes up, you get more interest on your bonds. If the T-bill rate drops, you get paid less.
How do the experts calculate the return on a bond?
They use something called "yield" to compare what you can make from different bonds. Yield is similar to, but not the same as, the interest a bond pays. It requires a very complicated formula to calculate.
Remember: Bonds pay interest
If you hold a bond until it matures, you know what you will make. You also know you won't likely lose the money you invested. And if interest rates drop, you may sell a bond for more than you paid.
Content in this section is provided in partnership with the Investor Education Fund, a non-profit organization promoting financial literacy to Canadians. To find out more go to GetSmarterAboutMoney.ca.