Investing in bonds

Bonds are issued by governments or companies when they want to raise money, but don’t want to issue more shares. Essentially, it’s an IOU, with a fixed term and regular interest payments at a rate set when the bond is issued (these payments are often called the coupon). When the term ends the issuer repays the original loan – the principal – to the bondholder. 

Bonds can be issued by governments and companies. Bonds issued by companies are often known as ‘credit’. ‘Gilts’ is a nickname for UK government bonds, US government bonds are often called ‘Treasuries’, while German government bonds are often referred to as ‘bunds’. They are all bonds, though, and all work the same way. 

Unlike the loan you might take out to buy a car or mortgage on your house, bonds aren’t negotiated with a specific lender. Instead, the issuer lets it be known that they want to issue a bond of a certain amount, along with how long they want to borrow money and the interest rate, and investors are invited to take part. 

Once they’ve accepted the bond – and given the bond issuer the principal – the bondholder can keep the bond until the end of the term – when the principal is returned – or sell it on to another investor before that time. 

Bonds are less unpredictable than shares: the return profile of a bond is more or less set when it is issued and in tough times bond issuers will prioritise paying their debts over issuing dividends for shareholders. 

Bond prices tend to fluctuate less than share prices, and there is a smaller chance of big losses for bond investors than for investors in shares. Conversely, there is also less opportunity to make big gains. 

Rather than talking about prices, bond investors typically talk about rising or falling yields. The yield represents the return an investor will get on a bond, taking into account the coupon, the principal and how much an investor paid to invest assuming it runs for its entire term. 

The more an investor pays for a bond, the lower the yield will be. So, if bond prices are rising, this will be expressed in investment commentaries as falling yields; conversely if bond prices fall then commentaries will talk about yields rising.  

This can feel a bit topsy-turvy: falling yields are good news for bond investors – the value of their portfolio is rising; rising yields are bad news, as the value of the bonds they hold is falling. 

Individual investors are less likely to buy bonds directly. Bonds tend to sell for millions of pounds or more, making them out of reach for most individuals. 

However, bonds can be packaged into a bond mutual fund where an experienced fund manager will pick and choose bonds to hold on behalf of investors. 

 
Over the  long-term, bonds are riskier than cash savings but less risky than equities. However, as is the general rule of thumb when it comes to investments the greater the return on offer, the bigger the risk involved.