Bonds are IOUs issued by companies and governments to raise money. When you buy one you are effectively lending money to the issuer. In return, the issuer promises to pay you a set rate of interest each year and to repay your capital at a set date in the future. The investment period is typically five years. The minimum investment is normally £5,000.
Bonds are a halfway house between deposit accounts and shares. Both government and company bonds can be traded so you do not have to keep them to maturity. This means their price can fluctuate, like shares, but usually only very slightly. And they’re relatively safe because if the company that issues the bond goes bust, bondholders are ahead of shareholders in the queue for payoffs.
Bonds are attractive, especially when returns from deposit accounts are low, because of the regular income they offer . They are also popular in times of stock market turbulence as investors retreat into less-risky forms of investment.
However, the value of bonds can rise or fall depending on interest rate conditions. Bond prices are linked to long-term interest rates. They fall when interest rates rise because savers move into top-paying deposit accounts. Conversely prices rise when rates fall and so increase the demand for bonds. Any income earned from a bond is taxable unless it is held in an Isa, in which case the interest is tax-free.
There are two main types of bonds:
Gilts, are issued by the Government.
Corporate bonds, are issued by companies.
There are also insurance company bonds which are different from the other two. And the word bond is also used to describe fixed-term savings accounts from many banks and building societies and from National Savings.
Fixed-rate bonds from banks and building societies are paid after tax – though non-taxpayers are exempt. But insurance company bonds are paid net of tax which cannot be reclaimed. They are, therefore, not suitable for non-taxpayers.
Bonds can be ideal for those looking for a set return on their money with little risk to their capital. The type which suits you best depends on the amount of tax you pay and how much you have to invest. You can buy corporate bonds using a stockbroker (see TAKING ADVICE – Stockbrokers). For Gilts, you can use the Bank of England Brokerage Service, telephone 01452 398 333. Or you can invest in a corporate bond unit trust where a professional manager will select which bonds to buy and sell.