What are fractional bonds and how do they work?

Fractional bonds are portions or “fractions” of a full bond that can be bought or sold in smaller amounts than the bond’s original face value. They make bond investing more accessible to smaller investors by allowing them to invest smaller amounts.

Example: Say you want to buy a $1000 bond but only have $1 to invest. With fractional bonds your dollar can buy you 1/1000th of that bond.

How do fractional bonds work?

Fractional bonds work the same way regular bonds do but investors buy a portion of a traditional bond instead of the whole thing – and any return is in proportion to the ownership stake. The process might look like:

1. A bond is issued as normal – say a $1,000 government or corporate bond that pays interest every six months.

2. A financial platform or intermediary (e.g. Bondao) splits the bond into smaller parts, for example, into 100 pieces worth $10 each. These are the fractional bonds.

3. You buy one or more fractions – so if you invest $100, you own 10% of that bond. Behind the scenes, the financial platform or intermediary holds the full bond, while keeping records of who owns which fraction. You don’t have direct possession of the bond, but you do have a legal claim to your share of its returns.

4. You earn interest (coupons) in proportion to what you own. If the bond has a 5% interest rate, it pays $50 a year in interest and you’d get $5.

5. When the bond matures, you get your share of the principal (the original amount) back – in this example, $100.

6. You invested $100 and got $105 back, which means your money kept up with inflation and even earned you a small profit – although this amount depends on the current inflation rate.

How do they work with Bondao?

It starts when Bondao invests the $1000 or $10,000 to buy a whole bond or parcel of bonds. Then we make them available to users on our platform as fractional bonds, while keeping records of the different ownership stakes.

This approach means we’re investing alongside our users – we take on the same level of risk as you do. It aligns our incentives with our users, by design, because we only succeed when you do. We can grow only by your growth, not in spite of it. This is not a typical model in finance, and it makes it absolutely essential for Bondao to manage money carefully and responsibly.

What’s the point in fractional bonds?

Fractional bonds lower the upfront costs of bond investing for those who have less money available to invest. Whether you’re a part-time worker, a student, or a cash-strapped homeowner, fractional bonds mean you can:

• Diversify your investment portfolio to enhance stability and reduce risk

• Benefit from the bond’s listed interest rate without the minimum investment amount needed for a full bond

• Invest in traditional safe-harbour assets with the money you have, when you have it

• See the expected return on your investment before you buy it

• Plan for your future cash needs and enjoy knowing what you’ll earn, and when

• Put your money to work by funding projects and companies that align with your values, such as supporting your community, or improving your local area

• When share or crypto markets crash, enjoy the security of knowing your investment is much less susceptible to losses (only if the company goes bankrupt or defaults on its loans)

Pros and cons of fractional bonds

The good

• Empowers you to choose how your money makes money

• Lowers the costs and barriers to access safe-harbour assets

• Allows diversification across bond holdings and entire investment portfolios

• Manage your cash flows long into the future, starting with where you are today

• Provides clarity and transparency into returns and timeframes upfront

The bad

• Returns might be lower than what you can potentially make in other assets

• Bonds will not make you an overnight millionaire – they work slowly and steadily over time

• Bonds can be harder to get your money out of early, if the unforeseen should happen

• Regular trading or selling before maturity can expose you to losses

• Although generally much lower risk than equities or crypto, bond issuers can still default resulting in losses

Who can benefit from fractional bonds?

Bonds may be suitable for those looking for relatively low-risk investments, compared with other commonly-available investments (such as shares). They often offer higher interest rates than savings accounts, and the funds raised are typically used to support infrastructure and Government projects, rather than activities like guaranteeing mortgages.

Fractional bonds can be a good option for those who don’t want to invest the full amount of a whole bond upfront. They may suit people who want to make regular investments in smaller amounts, or who want to diversify their bond holdings with the ability to control what exactly they invest in, unlike a bond fund.

For those looking to diversify their portfolio overall, beyond shares, cryptocurrency, or property, fractional bonds are a great way to get into the bond market.

FAQs

• What are fractional bonds?

  Fractional bonds are portions or “fractions” of a full bond that can be bought or sold in smaller amounts than the bond’s original face value. They make bond investing more accessible to smaller investors by allowing them to invest smaller amounts.

• Why would I invest in fractional bonds?

  Fractional bonds lower the upfront costs of bond investing for those who have less money available to invest. They may suit people who want to make regular investments in smaller amounts, or who want to diversify their bond holdings with the ability to control what exactly they invest in, unlike a bond fund.

• How do I invest in fractional bonds?

  Currently, there’s no platform in New Zealand offering fractional bonds in a fully retail-friendly way (i.e., low minimums, NZ dollar settlement, local regulation).

  Global solutions are also limited – and those offering fractional bonds often have large minimum investment amounts, with Public, Mintos and WiseAlpha being the rare exceptions.

  Bondao is working hard to allow New Zealand investors to access fractional bonds. Watch this space.

Disclaimer: This content is not financial advice. The information above is general only and current at the time it was written. It does not take into account your objectives, financial situation, and individual needs. If you require financial advice, you should consider speaking with a qualified financial adviser, or seek independent advice. Always read the product disclosure documents available from the product issuer before making any financial decision. And remember, investing involves risk.