An Introduction to Bonds

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An Introduction to Bonds

If you’ve been scouring the internet looking for the correct investments that you need to make for your individual portfolio, then you may have come across bond investments.

To break them down in a simple-to-digest format, we’re going to give you everything you need in this article to make an informed decision on whether a bond investment will suit your wants and needs.

 

What is a Bond?

In investing, a bond is known as a type of security that is issued by the government or businesses when they want to raise money for their project. By investing in the bond, you’re allowing the government or corporation to go ahead with their project, and they have to pay you back via fixed-income or fixed-interest payments.

Essentially, in simple terms, when you buy a bond, you’re lending money to the company or government. In return, they have to pay you back the borrowed amount (the principal) at a predetermined future date, called the maturity date, along with additional and routine interest payments to go on top of the borrowed amount.

 

Bond Terms You Need to Know

Before getting into the technical side of bond investments, we thought it’d be a good idea to break down a few key terms you need to know. This way, you’ll be able to read along without feeling as though you’re far behind.

  1. Coupon rate: This is the fixed interest rate that you’ll be paid when you buy a bond (oftentimes received on a 6-month to annual basis).
  2. Maturity date: This is essentially the ‘due date’ or ‘deadline’ where your bond issuer has to pay your initial investment back to you.
  3. Issuer: The issuer is simply the company or government that is borrowing the money from you.
  4. Face Value: This is just the price tag of the bond that you have to invest in, which the issuer has to pay back at the maturity date.
  5. Yield: The yield is essentially the annual returns you can expect to receive from being invested in a specific bond.
  6. Duration: This is described as how sensitive a bond is to interest rate changes.
  7. Call Option: This is the issuer’s right to redeem a bond before its maturity date (look out for this as you could lose out on lots of money).

 

Types of Bond Investments

In the UK and beyond, there are a few different types of bond investments. Here are the only major bonds that you will need to know about:

 

Gilts (UK Government Bonds)

A gilt is a bond investment that is backed by the UK government. This means that you’re relying on the UK government to pay your coupon rate and interest payments over time. Due to it being the government, you can almost guarantee the trustworthiness of the bond, and you should receive everything you qualify for on time.

 

Treasury Bonds (US Government Bonds)

Just like the UK gilt, a Treasury bond is the US version of that. Typically, a Treasury bond will have a maturity date of over ten years, meaning you will receive the principal amount back after ten years or more. However, you will receive coupon payments or interest payments during this time period.

 

Corporate Bonds

A corporate bond has the exact same philosophy as a gilt or treasury bond but is just backed by a company issuing the bond rather than the government. This means that you will be lending money to a business project while receiving interest payments.

Like gilts, you’ll receive your principal amount back at the end of maturity, but there tends to be more risk in investing in corporate bonds because you don’t know if the business will fail or not during the time you’re invested in them.

 

Municipal Bonds

The last main type of bond is a municipal bond, which will be issued by local governments, cities, towns, or states in order to fund local projects. This could be anything from the construction of bridges to building/renovating schools in the local area, and pretty much anything within the public sector.

The key thing to remember about municipal bonds is that the interest payments are often tax-free, but it is always important to check the bond details in full.

 

Why Would I Buy a Bond?

To understand why it may be beneficial to invest in a bond, here are some key advantages you need to know:

  • You often get safe, predictable returns
  • You are virtually guaranteed to get your initial investment back
  • They allow you to spread out your risk across your portfolio
  • They are perfect for upcoming or already retired people (little risk of losing money)
  • They won’t typically go down in a bad financial market like the stock market
  • It is convenient and non-time-consuming to invest in

 

Why Wouldn’t I Buy a Bond?

Every investment has its pros and cons and bond investments are no different. Here are some of the disadvantages you can expect:

  • There is a chance (especially with corporate bonds) that a call option will be taken
  • They are sensitive to interest rates
  • The returns are not as good as the stock market (on average)
  • You can get misled into funding a project that won’t work (do your research)
  • Fixed-rate payments will lose purchasing power if inflation rises quickly

 

10 Tips You Need to Know Before Investing in Bonds

Before putting a large sum of money into bonds, you need to know some crucial tips before making the jump:

  1. Knowing and being okay with the maturity date of the bond
  2. Research the bond issuer’s track record on payments
  3. Understand what the bond’s rating is (the higher the rating, the lower the risk)
  4. Can you keep the bond until maturity safely?
  5. Consider the current interest rates
  6. Define what your risk tolerance is and stick to it
  7. Factor in inflation when you look at the returns
  8. If you’re soon retiring, you need to consider bonds more than others
  9. Understand if there are any underlying fees you’re going to pay
  10. Read the terms and conditions in full; it’ll be worth it

 

Factoring in these tips, along with doing your own research on top of them, should be paramount. Once you understand and have asked yourself these questions, you’ll be ready to move on to the next stage… investing in bonds.

 

How to Invest in Bonds

In the UK, there are a few ways you can invest in bonds. One of them is by directly investing in them through the UK’s Debt Management Office, using a trading platform (secondary market) such as Vanguard, AJ Bell, Hargreaves Landsdown, etc., or investing in bonds indirectly via investment funds, which gives you the ability to hold a mix of bonds.

 

In Roundup

If you’ve read this article and consider bonds to be a great investment that aligns with your goals, then it may be worth contacting them and beginning your journey via one of the methods above.

However, one note is that you should always check the bond market before buying to see whether you’re getting a fair bond price for the one you’re investing in.

These investments are great for those who want low-maintenance, steady returns, but not great for those who want higher returns and can afford to be more risky with their investments. Get knowledgeable, ask yourself what you want, and the answer should always prevail.

Are you searching for investments which outperform bank interest rates?​

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