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Investing in bonds is an increasingly popular option for both new and established investors. By pinpointing the best bonds to invest in and learning how to buy bonds to complement your portfolio, you can take advantage of a relative haven in times of widespread economic uncertainty.
What Are Bonds?
Bonds are issued by companies and governments as a means to raise capital. Investment bonds are essentially IOUs, which are purchased by investors and held for an agreed period. This period can be anything from a few months to several decades, as pre-agreed between the two parties at the time of purchase.
The incentive for those buying bonds is a relatively high fixed rate of interest, over the course of the agreed term. This type of investment payment is referred to as ‘the coupon’ and is almost always fixed for the whole term of the bond.
The initial price of a bond is referred to as its ‘par value’ and the end date of the agreement is known as ‘maturity’. When the bond matures, the full par value is paid back to the investor.
What Are the Risks Associated with Investment Bonds?
As with all types of investments, there is a risk of capital loss when investing in bonds. It is the responsibility of the investor to fully assess the credibility and creditworthiness of the bond issuer, as problems at any point during the bond’s lifespan could result in the original capital not being returned in full.
Bonds that are offered with a disproportionately high rate of interest usually carry the highest risk of potential capital loss. This does not necessarily mean that low-interest bonds are always safe, but those with seemingly higher rates of interest must be carefully considered and approached with caution.
UK Government Bonds
Generally considered the safest investment bonds, government bonds are known as ‘Gilts’ and present minimal risk of capital loss. This is due to the fact that in order to repay its debts, the government has the power to raise taxes and ensure it is able to meet its obligations.
The length of a Gilt agreement has a major impact on the annual rate of interest payable to the investor. At the time of writing, a two-year bond is offering an interest rate of 0.5%, whereas a 30-year Gilt attaches a 1.75% rate of interest.
Corporate Bonds
A corporate bond is considered a higher-risk investment, though can potentially provide the investor with access to much more generous rates of interest. Investing in corporate bonds safely means conducting the necessary due diligence, in order to establish the credibility and track record of the bond’s issuer.
Corporate bond investors must ensure they have a comprehensive understanding of the issuer’s credit status and financial situation, so as to assess the likelihood of receiving their capital back in full.
