A Guide to Investing in Bonds

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Introduction to Bonds

In terms of the risk they carry, bonds sit somewhere between cash and shares. They come in various shapes and sizes and it’s easy to become overwhelmed when researching them, especially if you’re a newcomer to this particular area of finance.

To help you understand how bonds work and whether they’re the right investment choice for you, we’ve put together this guide.

The following topics are covered below…

What are bonds?

Bonds are basically IOUs, usually issued by companies and governments as a means of raising money. By investing in bonds, you are lending money to these firms/governments for a set period and generating income for yourself through fixed-rate interest. By the time the bond reaches maturity, your original investment should be repaid in full, in addition to the interest.

Government and corporate bonds are not the only kind you might come across. There are savings bonds too, which are usually issued by banks and building societies as interest-paying savings products, and they also function like a fixed-term loan between the customer and the provider.

How do they work?

A business, government or finance provider might sell a bond to fund activities, such as investments. When you buy a bond, you’re obtaining a debt to earn regular interest, known as ‘coupon’.

As we’ve already touched on, your original capital should have been recouped in full by the time the bond reaches maturity, although it is possible to trade them on the secondary market. In fact, it’s not uncommon for bonds to change hands between investors after they’ve been issued.

The price bonds are traded at depends on the current interest rates and how attractive the issuer is, in terms of factors such as their ability to meet their long-term debts and financial obligations.

When investing in bonds, you would usually have control over how long you want to invest for.

Where to buy bonds

The process differs depending on the type of bond you’re buying. Everyday investors who are hoping to buy corporate bonds won’t be able to go directly to the issuer. You’ll need a stock broker to do this, and this is where we come in. Make an enquiry and we’ll match you with one for free.

The corporate bonds brokers we work with will help you choose which corporate bonds to invest in, the length of the bonds, the yields (interest rates) and the level of risk.

Savings bonds are bought directly from banks and building societies. You will need to open an account with the lender (if you don’t have one already) and deposit at least the minimum amount that they specify (£500 to £1,000 is standard). Although seeking professional advice before you proceed isn’t mandatory, it pays to do so as there may be alternative savings products to consider.

If you are based in the UK, you can buy government bonds (gilts) directly from the British government via its Debt Management Office online portal. The minimum investment is £100 and you can buy them in multiples of this, with lengths usually starting from just two years.

An alternative to buying bonds directly is investing in collective funds such as unit trusts or open-ended investment companies (OEICS), which pool your money with other investors and invest it into a range of shares, gilts and bonds to spread the risk across multiple asset classes.

You can read more about investing this way in our in-depth guide to unit trusts.

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Pros and cons of investing in bonds

The advantages of investing in bonds are as follows…

  • There are a wide range of markets to invest in
  • They can offer regular interest payments
  • The freedom to choose how long to invest for
  • Different risk levels available

The potential drawbacks can include…

  • You can’t cash out of a bond before it expires
  • Gilts and corporate bonds are not covered by the Financial Services Compensation Scheme
  • Low risk bonds tend to come with low yields
  • Some bonds, such as those issued by foriegn governments, are difficult to buy

The above information aims to offer a snapshot of the advantages and disadvantages of investing in bonds. For an in-depth discussion about which pros and cons are likely to apply to you, make an enquiry to speak with an expert financial advisor. They can highlight all of the potential rewards bonds could offer you and offset them against the level of risk you’d be taking on.

Are they a good investment?

If you need regular income from your investments, bonds might be an option due to the way they generate interest, but many experts often recommend them to help balance investment portfolios against more volatile investments, such as equities. Bond and equity prices generally move independently of one another, so having one can help offset the risk of the other underperforming.

Whether bonds are a good investment will also come down to the type of bond in question. Government bonds, for example, are low risk but usually offer a lower rate of return. An advisor can help you decide which bonds to invest in and in what quantity, based on your personal profile.

Corporate bonds, meanwhile, can be a good investment if the issuer is attractive from a commercial standpoint. Establishing how worthwhile a specific bond is requires a thorough assessment of the firm’s cash flow, debt, liquidity and business plan. Everyday investors might struggle to understand these factors, but the bonds experts we work with would be happy to do the analysis for you.

Ultimately, the question of whether bonds would be a good addition to your portfolio is one you should put to an independent financial advisor. They can assess your needs, circumstances and appetite for risk to establish whether this type of investment is more viable than the alternatives.

How much does a bond cost?

The minimum amount you will need to invest in bonds will depend on the type of bond you invest in. With corporate bonds, issuers can specify as little as £50 or as much as £50,000. For savings bonds, banks and building societies usually set a minimum deposit amount of £500 to £1,000.

Government bonds can be bought for as little as £100 and in multiples of this sum.

Keep in mind that there could also be additional costs to foot, such as broker fees if you’re buying corporate bonds through a stock broker.

What are the best bonds to buy?

Interest rates and the potential returns a bond could offer you can change at any time, especially during volatile market conditions. The best type of bond for you will depend on a number of factors, including how long you’re willing to invest for and your appetite for risk.

Given that the market is always in flux and a bespoke assessment of your investment needs is essential, your best bet is to speak to an independent financial advisor before you decide to add bonds to your portfolio. They can help you make the right investment choices based on your circumstances and preferences. Make an enquiry and we’ll introduce you to an expert today.

What is the best way to compare bonds?

You should make sure you’re comparing the bonds on offer across the entire market, or at least getting a representative snapshot of it. Working with an independent financial advisor can give you an accurate, whole-of-market bonds comparison, but it doesn’t hurt to do a little market research yourself too.

Here are some key points to consider when comparing bonds…

  • Research how much credit risk you’re taking. If the company or entity you’re investing in goes under, you could lose the money you put into the bond
  • Consider how long the bond will take to mature. The longer it takes, the more sensitive the bond will be to interest rates
  • Remember to factor in how inflation will affect your principal
  • Compare the level of risk with the yield. If the risk is higher than what you’re comfortable with, consider whether another type of bond (e.g. gilts) is more viable

Customers without investment know-how might struggle to grasp some of the above, and this is where a financial advisor comes in. The bonds experts we work with can compare bonds across the whole of the market for you, assess the level of risk and forecast how much returns your investments are likely to bring in, as well as steer you towards the right investment decisions.

How to compare savings bonds

Comparing savings bonds is less complicated as the main thing you’re looking for is the rates and deals available at banks, building societies and other lenders. Online rates tables can offer a rough idea here, but keep in mind that they aren’t bespoke to you and often include sponsored products.

An independent financial advisor, like the ones we work with, can compare the entire market for you and provide you with a list of products tailored to your needs.

The experts we work with can also compare the savings bonds currently on offer with alternative products, such as ISAs, to find the savings option that’s best suited to you.

How safe are bonds?

The answer to this question varies depending on the type of bond in question. Government bonds are considered a very safe investment but offer a lower potential for returns compared to corporate bonds. With corporate bonds, they are only as safe as the company issuing them, and there is some risk of capital loss if the firm was to underperform or go bust.

Savings bonds are considered safe as they are protected by the Financial Services Compensation Scheme (FSCS), which has a cover limit of £85,000 (£170,000 for joint accounts) per authorised firm. If you have more than the limit, it’s worth moving the excess to another protected account.

Speak to an expert

The bonds market is vast. There are several different types of bonds that you could choose to invest in and countless companies and entities issuing them. With these things in mind, making the right investment decision isn’t always straightforward, but the advisors we work with are on hand to help.

We work with a team of bonds experts who can help you decide whether this type of investment is what your portfolio needs. They can highlight the potential rewards on offer and offset them against the level of risk, all while giving you bespoke investment advice every step of the way.

Call 0808 189 0463 or make an enquiry and we’ll match you with a bonds expert today.

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