Bonds allow you to diversify your investment portfolio, all while being able to earn some passive income each year.
For seniors especially, bonds can carry less risk than the more volatile stock market. It is for this reason many consider bonds either in addition to or instead of other forms of investments.
Although this reduced risk does mean the financial returns are often less, by the same token bonds offer a sense of reassurance, especially for those willing to be patient with their investment.
But when it comes to buying bonds, there can be a lot to wrap your head around, especially if you’ve never bought them before. In today’s guide, we’ll take you through everything you need to know, including a look at what bonds are, along with the pros and cons you should consider before buying bonds.
What Are Bonds?
Bonds are types of loans which you can offer the likes of the government, banks or companies in exchange for regular interest payments. It’s possible for bonds to be purchased by banks, insurance companies, pension funds or individuals.
How bonds work is that you choose the entity to which you want to ‘loan’ money, such as the government or a company. The interest rate will determine how much you receive each year. Once your bonds reach maturity (i.e. after a set 10 year period), your original investment will be paid back to you.
It is sometimes possible to cash in bonds before they reach maturity, and there are two reasons why you may wish to do this. The first is due to a fluctuating interest rate, as we have seen as of late, meaning your original rate may not be as attractive as it could be, had you taken out the bond at the current time.
Another reason someone may wish to cash their bonds early is due to the potential risk of the entity where your money is held, which is more common with private companies rather than government bonds.
Unlike with stocks, bonds do not mean you own a percentage of the company. Instead, you are temporarily loaning money to a company or government, so that it can fund projects or grow its business entities.
Bonds Terminology To Know
Coupon – The fixed amount which will be paid to you which is based on the interest rate at the time the bond was issued, along with the monetary value of the bond.
Issuer – The entity (i.e. a company, bank or the government) who is borrowing the money from the bond purchaser (you).
Market value – The current trading price of the bond.
Maturity – The length of time the bond is issued for, and the date at which it will be repaid. Bonds can be classed as short-term (up to 3 years), medium-term (up to 5 years) or long-term (10 years or more).
Risk – Denotes the likelihood that the issuer will default on their payments. Typically, the higher the coupon figure, the riskier the bond is. Bonds are given credit ratings ranging from AAA to D to guide investors on the risk of that particular entity.
Types Of Bonds
The main decision to make with bonds is who you want to purchase them from. While many separate entities exist, they can best be described as corporate bonds or government bonds, which are also known as gilts.
As with any kind of financial investment, it should be a personal, well-researched decision as to which type you opt for, and from there, which company you decide to purchase bonds from. Here is an overview of each type to tell you more.
Corporate bonds – Issued by companies and banks. It’s possible to find high grade corporate bonds which have a rating of between AAA-BBB. On the other end of the scale, speculative or ‘junk’ bonds have a rating of BB or lower and offer a higher coupon rate due to the increased risk the issuer will default.
Government bonds (gilts) – Known as ‘treasuries’ in the US, in the UK government bonds are known as gilts. Most gilts have a fixed coupon rate, although it is possible to find some which are linked to inflation. There is often far less risk with a gilt compared with corporate bonds but with that comes a reduced coupon rate.
Buying Corporate Bonds
Buying a corporate bond has been made easier in recent years, with many providers now offering an online service.
For instance, Hargreaves Lansdown has a full list of corporate bonds showing the coupon, maturity date and price of that bond. The bonds available range from banks to energy companies, mortgage companies and even supermarkets.
Alternatively, similar to stock trading platforms, there are a number of platforms which offer bonds and in some cases gilts too. One such example is Interactive Investor which offers more than 40,000 investment options in total.
Banks such as Barclays also offer a ‘plan & invest’ service to help you manage your bonds if you are investing at least £5,000. This means you’ll receive a tailored plan, rather than being left to figure out which bonds to invest in yourself.
Whichever platform you choose, purchasing corporate bonds will usually require you to pay a flat fee, or a monthly fee depending on the provider. Always research the provider thoroughly to ensure they are a reputable company before investing your money. This is in addition to carefully considering the credit rating of the bond, in line with your comfortable risk limit.
Buying Government Bonds
Governments usually sell their bonds to financial institutions or through auctions, on what’s known as the primary market. It is possible to purchase gilts as an individual if you go through the secondary market, which involves purchasing through a bank, stockbroker or the DMO’s purchase and sale service.
To purchase a gilt through the DMO, you will need to fill in a form known as the ‘Gilts Stock Dealing Form’. It must be sent through the post with a cheque. The cheque must originate from a UK bank account that is in your own name. You’ll then be issued with a certificate, and when you want to sell your gilts you’ll need to fill out another form called ‘Gilts Stock Dealing Form’.
Advantages Of Buying Bonds
- Bonds offer a way to diversify your investment portfolio.
- Often far less risky than the stock market, depending on the type of bond and its credit rating.
- Interest rates on bonds tend to be higher than traditional savings accounts, which could offer a better ROI in the longer term.
- It’s possible to buy bonds from a variety of entities, allowing you to select the type of investment and risk you are most comfortable with.
- The purchase of a bond often comes with a wealth of information about that bond so you can make a careful consideration, whereas with stocks you can instantly buy and sell them leading to more risk.
- In the UK, there can be tax benefits associated with buying bonds.
- Overall bonds offer more predictable financial returns.
- Bonds don’t have the same ‘thrill’ as the stock market, instead requiring you to be patient especially with the longer maturity times.
- Some bonds carry a high level of risk. Opting for a safer bet will result in lower financial returns.
- The purchase of government gilts can be complicated.
- The issuer’s financial stability may change over time, meaning you’ll need to keep an eye on your bonds.
- Secondary sellers will charge a flat or monthly fee for their services, so you’ll need to factor this into your overall ROI.
- Whatever your initial investment, remember that by the time you are paid this back when your bond reaches maturity, it will be worth less due to inflation, especially for longer term bonds of 10 years or more. That’s why the coupon rate is key.
Buying Bonds In The UK FAQs
Still, have some questions about buying bonds? You can leave us a comment below, or check out further advice on our finance and pensions section.
In the meantime, we’ve answered some of the most common queries about bonds below.
Can You Get Rich From Investment Bonds?
As with any type of investment, the goal is always to make money. However, the amount of money you will get back depends on the maturity rate along with the credit risk of that bond. Bonds with a higher credit risk will offer the best returns, though also carry the greatest risk the issuer will default on their payments.
Also, what one person deems to be a lot of money may not be for another. So while technically yes, you can ‘get rich’ from investment bonds, they are by no means a get-rich-quick scheme. Instead, patience is the name of the game.
What Affects The Price Of Bonds?
There are four main aspects which will affect the price of bonds. Alongside interest rates, market conditions, time until maturity and the credit rating of the bonds will influence their value. Publishers such as Forbes and Financial Times both provide regular updates on the market conditions for bonds, so it’s worth keeping up to speed with how the market is fairing overall.
How To Find Bonds To Invest In?
There are various platforms and institutions where you can purchase bonds, alongside the UK Government’s Debt Management Office (DMO). It is then a case of looking at the credit rating of that bond, which will influence both the risk and the potential returns. Once you find a bond you are comfortable with, you can make a purchase either on the primary market or on the secondary market for government bonds (gilts). As with any investment, you should always seek independent finance advice before parting with your capital.
How To Buy Premium Bonds?
Premium bonds are a product of NS&I and can be purchased via their website. It’s good to note that premium bonds work slightly differently to traditional bonds. That’s because you’ll be entered into a prize draw to win cash, rather than being paid an income for your investment. This means you could invest your money into a premium bond, but never see a financial return from that investment.
Stocks Vs Bonds: What’s The Difference?
Stocks allow you to purchase part of a company, and the price of that stock will fluctuate depending on how the stock market is fairing. In contrast, bonds are when you loan the government or a company money over a fixed term and collect interest until that bond reaches maturity, at which point your original investment will be returned to you.
Are Bonds Worth It?
For anyone wanting to earn an ROI on their capital with typically less risk compared with stocks, bonds can offer a predictable income. Bonds also offer a way to diversify your portfolio, making them a great option to consider alongside other forms of investments. So as for the definite answer of whether bonds are ‘worth it’, that all depends on what you are looking to get out of your investment.
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In summary, bonds are a way of earning money back for loaning your capital to the government, banks or private companies.
While each bond will carry with it a different level of earning potential along with risk, bonds are less volatile on the whole which is why they are so appealing. So if you’re not in the market for a quick gain and are prepared to be patient, UK bonds are certainly worth considering.
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