Local independent financial adviser, Becky Hammonds of Willow Financial Solutions, explains what bonds are and whether they are a worthwhile investment vehicle.
Governments around the world issue bonds in order to borrow money. In the UK they are known as Gilts or sometimes fixed income investments that provide a fixed rate of return until they expire.
Short-dated bonds are those that mature fast, and in normal times are deemed less risky as a result. Long-dated bonds are those where investors have to wait a while to see their money again, and are regarded as riskier because there is more time for things to go wrong.
Investors, including banks, insurers and pension funds as well as individuals, buy Governments issue bonds with a range of different maturities – three months, a year, 10 years and so on.
Ten-year bonds are the ones discussed and watched most closely by financial pundits and interested parties who are outside the industry.
While bonds are maturing, governments pay interest, called the coupon, to investors. At the end, they pay everything back, assuming they don’t default, meaning they are effectively bust. In the meantime, bonds are bought and sold in the massive global market for government debt.
Bond prices are the cost of bonds, or what investors pay to buy the debt.
Government bonds are considered a relatively safe investment compared with stocks and corporate bonds – which means company rather than government debt – and are held as a form of ballast in many portfolios and pension funds.
High demand for bonds reflects an investor flight to safety, which is what happened after the financial crisis in 2008.
They provide a higher income than savings at a time of rock bottom interest rates, and are perceived as less volatile than shares.
There are three key risks:
Market risk: Inflation and/or interest rates rise which we are currently experiencing.
Credit risk: The bond issuer defaults and fails to make an interest payment or repay the loan.
Liquidity risk: The bonds can be difficult to sell if and when you need to do so.
Inflation fears mean investors become unwilling to get locked into bonds at interest rates that could well lag increasing prices over the years to come.
This can leave bond holders sitting on capital losses as their prices drop, although new buyers are now getting higher yields.
If you are interested in finding out more about investments, such as bonds, it would be good sense to talk to an independent financial adviser.
For pensions and investment advice contact Becky Hammonds on 07969 269677 or email becky@willowfs.co.uk.
