What are they?
Issuing bonds is one way that institutions can raise money. Think of them as IOUs. In return for lending your cash to these companies or governments for a fixed period of time, the issuer promises to make regular interest payments. The issuer also promises to give you back your original amount at the end of the period.
UK government bonds are known as ‘gilts’, while those issued by companies are called ‘corporate bonds’. Both types are generally seen as being a lower risk option to investing in the stock market, although this does depend on the individual issuer. Bonds are not risk free – while it’s extremely unlikely that the UK government would ever default on its obligations, there is the chance that a company might be unable to pay the interest payments, or the original amount – this is called defaulting. To compensate for this risk, bonds will offer a particular rate of interest that reflects the risk rating of the issuer.
Bonds are rated so investors know the level or risk they are taking on. The highest investment grade is AAA – this means the risk is deemed as extremely low. A bond rated AAA offers more security but lower profit potential than a single A-rated or a BBB-rated bond. All of these bonds are considered to ‘investment grade’. However, any bond rated BB or lower is deemed to be speculative and is therefore categorised as sub-investment grade or high-yield.
Bond ratings are liable to be up or downgraded at any time as a country or company’s financial strength and level of debt changes.
You might also hear bonds referred to as a ‘fixed interest’ or ‘fixed income’ investment, this is because they offer investors interest payments (income) at a set rate for a defined period of time.
Despite the similarity in name, they are not related to ‘investment bonds’, which are separate products sold by life insurance companies.
What are the benefits?
Although they're viewed as a safer option than equites by investors, like any form of investing, bonds do have an element of risk. However, including them in a broad-based portfolio should help broaden and therefore lower your investment risk. The investment performance of bonds tends to move differently to that of equities, so holding bonds offers you a certain level of protection against stock market slumps.
Bonds can also provide you with a steady income stream.
In addition, in the event that a company is forced into liquidation and its assets are sold off to pay its debts, bondholders are prioritised ahead of its shareholders, or equity investors, in receiving the proceeds.
How do you invest in bonds?
Although the basic concept of bonds is fairly straightforward, selecting individual bonds to invest in yourself can be quite complex and daunting. For many investors, a collective bond fund managed by an expert in this area is a much preferred option.
Have a look at the range of bond funds we offer. Please select 'Bonds' from the asset class in the fund filter.A guide to bonds