Bonds – steady, income, steady
April 2009
If you are investing for income, you may be less concerned about protecting your capital than ensuring a regular and steady income stream.
Bonds are essentially loans (a bit like an IOU) to governments and companies. They come in all shapes and sizes from the relatively conservative “government gilts” (bonds issued by governments) to the wildly riskier “junk bonds” (issued by companies with a poor credit rating).
To find out more about how credit rating works see our feature on risk and reward Swings, roundabouts and see-saws.
What are bonds?
Bonds are sold in units with an ‘agreement’ that the issuing organisation will pay you a fixed rate of interest over a set term.
They can be short, medium or long term – anything from five to 30 years. Bonds are sold in units and each unit will have a “nominal value”, usually £100. At the end of the term the nominal value of your units is returned to you, assuming that the bond issuer doesn’t default and this is why it’s important to look at the risk level of the institution offering the bond.
Bonds are traded on the investment markets, just like shares, so the actual cost of a bond can vary. If a bond is attractive to investors the cost may rise above its nominal value.
The good and the bad
How to tell a good bond from a bad bond? Ask yourself the following questions:
Are you investing in government or in a company? If you are investing in a company, how stable is it; are they likely to default on the loan?
What is your attitude to risk? Will you enjoy a higher return than a savings account? Do you feel that the extra risk is worthwhile?
Remember, the more secure a bond investment, the lower the interest rate is likely to be. Government bonds generally offer lower interest rates than corporate bonds.
How do I invest in them?
Most people invest in bonds through a fund which helps to spread the risk. The investment company chooses a range of bonds with varying interest rates and redemption dates, aiming to give you a target return each year.
As with stocks and shares, government and corporate bonds can also be bought either directly through a stockbroker, financial adviser or private investment management firm.
Direct investment gives you more choice over the companies or organisations in which you invest. For example, you may choose to opt for the relative security of gilts (government bonds). These can actually be bought directly from the UK government’s Debt Management Office (DMO), through the Post Office® or through a stockbroker.
More information
For more information on how to buy Gilts, visit the DMO's website www.dmo.gov.uk
For registered stockbrokers, regulated by the Financial Services Authority, visit www.fsa.gov.uk
