‘Life is really simple, but we insist on making it complicated.’ A quote that pertains particular relevance to the bond market.
Bonds are in basic terms an ‘IOU’ which are issued by various companies and governments to help raise capital.
The process involves investors buying this debt, and in exchange, the issuer agrees to pay a set amount of interest and capital every year at a set date in the future.
The interest payment is known as a coupon and could be paid monthly, quarterly or yearly. At the bond’s maturity, you’ll get your initial investment back.
Sounds simple enough?
There are, however, lots of variables when it comes to bonds, for instance, it’s possible to choose between loans with different term lengths.
Of course, there’s a greater risk of interest rate changes or issuer defaulting over a longer period of time. The upside is that a longer-term bond may pay a greater percentage coupon.
Reasons to Invest in Bonds
There’s a variety of reasons why it can be of value to have some exposure to the bond market, in whatever form.
- The income generated by bonds can be attractive to those approaching or in retirement.
- With investment grade bonds, the risk of losses is just 1pc.
- Bonds can preserve capital (unlike shares)
- In this era of low-interest rates, the returns offered by bonds can be attractive.
- Have potential as a way to offset Brexit risk
Many still hold a large percentage of their funds in cash, which can be eroded by inflation. The statistics show that on average, bonds make up only 14pc of an investor’s portfolio when it is recommended to be much higher.
Types of Bonds to Invest In
There are a variety of bond types; fixed interest and fixed income, simply because they pay out a fixed amount.
The two main types of bond are corporate bonds (issued by companies) and government bonds (known as gilts).
To help assess how risky an investment is, bonds are rated in terms of their ‘credit risk’, so those rated from BB to AAA are known as investment grade bonds and issued by bigger companies, whereas those rated BB and lower are known as “junk” bonds (high-yield bonds) since they pay a higher amount of interest.
Tradable bond prices can fluctuate and investors should focus attention on the yield, which is a proportion of the bond price. Both have a correlation, meaning, if the price goes up, the yield goes down.
Mini-bonds are issued by companies but are unlisted, untradeable products. They should not be confused with retail bonds which can be traded on the London Stock Exchange (LSE).
Although riskier than a standard savings account, mini-bonds do offer retail investors an alternative to low-interest savings accounts.
You might wonder why companies prefer issuing a bond and not borrow from a bank, especially during as period of low-interest rates.
Although there are many reasons for this, the most common is that bank finance can often be very restrictive. Raising capital via bonds can offer greater freedom for the company to operate as they see fit.
So How do I Invest in UK Bonds?
There are many ways to invest in bonds.
Mini-bonds are usually available directly from the company itself and are available to retail investors.
The minimum amount of money needed to invest in these types of bonds varies. It’s usually more than £1,000, but it could be as low as £100.
However, an easier and simpler way for first-time investors to gain access to bonds is through a dedicated bond fund.
This is essentially where a fund manager will invest in a range of bonds on the investor’s behalf. The simpler process may be a more desirable option for first-timers, and the investments could be held in a self-invested pension plan or Stocks and Shares ISA.
Sophisticated and established investors may consider investing via a ‘fixed-income exchange traded fund bond’ (ETF). These track indices comprised of a basket of bonds. However, they can be very complex and are not for the feint hearted.
Of course, the downside of these tax-efficient options is that withdrawing any income will not be a simple task or not possible, and you may prefer to leave funds accumulating in your account.
If you’re interested in comparing the best savings accounts and investment bond rates then check out the top 10 on Best Savings Rate.Last updated: August 7th, 2017