Often seen as the less glamorous cousin of investing in companies, many people wrongly view bonds as too complex to contemplate. However, that’s not the case – bonds can be a steady performer in your portfolio of investments and are actually straightforward, so don’t dismiss the idea of them until you’ve read more.
What is a bond?
A bond is effectively an IOU. You lend money – let’s say £100 – out to another entity, usually governments and companies, for a fixed period; again, let’s say for 10 years. At the end of the term, you receive your £100 back, and each year you will receive a fixed amount of interest – say 5% (£5) each year.
Unlike stocks, bonds provide a relatively secure long-term regular income, and the peace of mind that should the company fail, rather than losing all of you investment, bondholders have the chance to claim company assets. They might not produce the sometimes-stellar returns of stocks and shares, but they tend not to give you sleepless nights.
Don’t put all your eggs in one basket
Having a portfolio made up of stocks and bonds is a powerful investment proposition because different asset classes (property, stocks, cash etc.) tend to react differently to the same political or economic factors e.g. a snap election.
By not putting all your eggs in one basket and spreading your investment risk, you increase the opportunity for higher returns. Many economists believe this diversification is the only free lunch that investors are able to enjoy today.
Our approach to investing in bonds
Bonds play an important part in our investment strategies, based on your attitude to risk. Our most defensive strategy is 57% invested in bonds. On the flipside, our most aggressive offering is only 2% invested in bonds.
Our defensive and cautious strategies tend to hold mostly ‘safe haven’ UK government bonds. As we move up the risk scale, our portfolios branch out into bonds that look to earn higher returns, such as corporate bonds. Generally speaking, there is a greater risk of companies not being able to pay back their ‘IOUs’ and interest than a government.
Where next for bonds?
Bonds have been on an impressive run for three decades offering a smoother, albeit slightly less profitable, ride than those investing solely in stocks and shares.
Yet, experts believe this ‘bull market’ is coming to an end. Whether the bond market is heading for a fall or a gentle alteration, no-one really knows.
Investing is like driving a car. Investing in stocks is more akin to driving fast. You may get from A to B quicker – generating higher returns – but there is greater associated risk. While bonds, broadly speaking, are in the slow lane; a safer option tending to give lower but more guaranteed returns.
It’s important in all of this to remember that bonds offer a way to spread your risk. You can also think of bonds as the brakes and stocks as the accelerator. Without brakes, a car would soon spin out of control. That’s why historically, bonds reduce the impact a crashing stock market will have on your investments.
Take a look at our short bond film to find out more about what the future may hold.