A complete guide

The Investment Bond Guide

Bonds offer you an investment option that can help you to grow your money over the medium to long-term. They are often described as being somewhere between cash and shares in terms of risk, providing more security and less volatility than the latter. They will typically allow you to make a profit over 5 to 10 years, or possibly longer.

Bonds might seem complicated at first, to a beginner, but it doesn’t take long to understand the basics of how they work and how they can help you reach your investment goals.

What Are Bonds?

A bond is basically like a loan to a company or government. The country or corporation issues the bond and you act as the lender, who will eventually receive their money back, plus interest. It’s used as a way to raise funds while also offering a benefit to those who choose to invest.

Bonds from governments and companies are some of the most common types, but you can also get savings bonds, which are usually issued by banks and building societies. Savings bonds are savings products that allow you to earn interest, usually more than you would get by simply using a standard cash savings account.

Bonds are also known as fixed-income securities because you know how much you’re going to receive in interest when you get your money back. You also know when the bond will reach maturity and your original investment will be repaid. Over the term of the bond, you receive a regular interest, known as a coupon. The riskier the bond is, the higher the rate of interest will typically be.

Other types of bonds

In addition to corporate and government bonds, municipal bonds, agency bonds, inflation-index-linked bonds (ILBs), and callable bonds.

• Municipal bonds are usually issued by local governments or nonprofits and are either general obligation bonds, which are not linked to a specific project, or revenue bonds, where the interest comes from sales, donations, or other revenue.
• Agency bonds are issued to government-sponsored enterprises and can have higher interest rates but in exchange for less security.
• ILBs will increase in value if inflation rises but can also be affected by negative inflation.
• With callable bonds, the issuer can pay it off before it reaches maturity. This means you could lose out on interest payments but this type of bond also usually has higher interest rates.

Bonds can be traded on the secondary market and it’s common for them to trade hands between investors.

The Risks of Investment Bonds

It’s always important to know the risks before you decide to invest in anything. Investment bonds can be lower-risk compared to various other investment products, such as stocks and shares, but it doesn’t mean that they are entirely without risk. There are various factors that can affect how risky an investment bond is and how likely you are to make a profit or potentially lose your money.

The primary risk to take into account when considering investment bonds is that the issuer could experience financial trouble. This means that, generally, well-established companies and stable governments are going to be the safest options for your investments. If the issuer gets into financial trouble, they may be unable to pay interest or could even be unable to repay the initial investment. Government bonds, called gilts in the UK, are viewed as being the safest option, although they typically have quite low-interest rates.

What impacts the price of bonds?

There are several factors that affect the price of bonds. Supply and demand have an impact on the price of bonds. The health of the global stock market also affects the availability of government bonds. When the stock market is performing well, the demand for bonds tends to go down because investors move their money into stocks instead. The prices of bonds can rise again outside of these periods because of higher demands. Many investors use them as a safe space for their money.

Bond prices can also be affected by changes in government monetary policy, such as a central bank raising the base interest rate. This can cause existing bond prices to decline if new bonds are issued with a higher interest rate.

How to Invest in Bonds

If you want to invest in bonds, you can either invest directly or via a bond fund. A bond fund holds multiple fixed-income assets, which helps to spread risk. If you want to buy corporate bonds, you need a stock broker to help you gain access to the bonds you’re interested in. Stock brokers will give you financial advice to help you make sure that you’re choosing the best investments for your goals and the level of risk that you’re comfortable with.

You can also choose to use an execution-only brokerage if you already have a good idea of which bonds you want to invest in. Even if you do this, it’s still a good idea to get independent financial advice to help you make your choices.

UK Government Gilts

In the UK, government bonds can be bought directly from the government. The Debt Management Office online portal is where you can find information about gilts and how to invest in them. You can choose between conventional gilts and index-linked gilts. Index-linked gilts are linked to the UK Retail Prices Index and are affected by changes in inflation. You can also explore green gilts, which have been created to help the government’s green objectives.

International investments

In addition to investing in government bonds in the UK, you can also look at the option of making international investments with other governments. UK investment bonds are known as onshore investment bonds, while offshore investment bonds is a term used to describe bonds issued in locations where interest payments may be largely free from tax.

What to Consider Before Investing in Bonds

Bonds can be seen as a relatively safe investment vehicle, especially if you choose government bonds over corporate bonds. However, there are still some important things to think about before you decide whether investing in bonds is the right option for you.

1. Understand the different types of bonds – make sure that you’re familiar with different types of bonds and how they work.
2. Consider your financial and investment goals – think about whether investing in bonds will fit in with your goals for the future. Many people choose to invest in bonds as they approach old age, as a way to benefit from a low-risk investment that won’t tie up their funds for too long.
3. Potential risks – bonds can be low risk compared to some other types of investments, but they’re not risk-free. It’s still important to assess the risk level of any bond before deciding to invest.
4. Get financial advice – receiving independent financial advice is always useful when you’re considering your investment options. It will help you to ensure your investments line up with your goals and your tolerance for risk.

Return on Investment for Investment Bonds

The return on investment for bonds will depend on a number of factors, including what type of bond you want to invest in.

Gilts will typically have much lower interest rates but they also offer the benefit of being low-risk compared to corporate bonds. However, some of them do have higher rates. You can find that the coupon for UK government bonds can start from around 0.125% but they could reach up to 5% or 6%.

In comparison, corporate bonds are much more likely to offer coupons of between 4% and 6%, with some as low as around 2%. Higher interest rates could reach 12% and beyond.

Another factor to consider is how much you may be required to invest and for how long. With gilts, the minimum investment amount is £100 and they can be bought in multiples of this. Corporate bonds can have a broad range of minimum investment requirements. Some of them might require an investment as low as £50, others could set a minimum investment in the tens of thousands. It’s also important to keep in mind that there may also be additional costs for you to cover, including broker fees.

Pros and Cons of Buying Bonds

There are both potential advantages and disadvantages to investing in bonds. Taking both into account before making a decision will help you to ensure bonds are the best choice for your investment portfolio.

Pros

• Choose a risk level that suits your goals
• Multiple markets to invest in
• Regular interest payments over a medium to long term
• A range of investment terms so you can choose how long to invest
• You can sell your bonds to other investors

Cons

• You only get your initial investment back when the bond matures
• The Financial Services Compensation Scheme doesn’t cover gilts or corporate bonds
• Low-risk bonds have to be balanced with low interest rates
• It can be harder to buy some types of bonds (e.g. bonds from foreign governments)

Get Professional Advice for Investing in Bonds

Before investing in bonds, get professional financial advice to ensure your investment goals align with your choices.

About Alex McCann - DipPFS & CeMAP

Alex graduated from Leeds Metropolitan University in 2013 and has worked in the financial services industry since 2016. Alex has completed the Chartered Insurance Institute Diploma in Regulated Financial Planning (DipPFS) and the London Institute of Banking and Finance Certificate in Mortgage Advice and Practice (CeMAP) qualifications.

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