15 September 2009

My Name's Bond

It gets pretty confusing when you talk about “bonds”. The trouble is that “bond” doesn’t mean much more than “investment”. Although to be a bit more precise it’s an agreement to pay a sum of money, with or without interest, on a certain date.

So some savings products are called bonds, because they have a fixed duration and fixed interest rate. Also insurance companies offer “insurance bonds” (which do not, actually, fit the definition). But here we shall be talking about “corporate bonds”, and we are considering these because they are, in some cases, an alternative to savings products.

Corporate bonds are investments (the “bond” bit) which can be bought from companies (the “corporate” bit). The agreement is that the company will pay a fixed interest rate for the life of the bond – which will be a number of years – and then repay the original capital on maturity (provided the company is still in existence). So corporate bonds fall into the “fixed interest” category of investments, along with others like Government gilts.

Most retail investors – that’s you and me – will buy corporate bonds via unit trust funds (or OEICs) where the fund manager buys a range of different companies’ bonds. For that reason, the interest paid out of the fund is not fixed as far as the investor is concerned – all very confusing!

So why am I talking about corporate bonds as an alternative to savings? Corporate bonds are generally very reliable in paying their interest, and in returning the capital value at maturity. They are generally pretty stable and unexciting as investments – just what you want when looking at alternatives to savings.

The irony is that, due to the upsets in credit markets, corporate bonds have been rather more exciting recently. Interest rates (or “yields”) have been unusually high (10% or more in some cases), and the capital values have been rather more volatile than usual, too.

That all goes to emphasise that values can rise as well as fall, as can yields. That’s why I describe them as a step up from savings. But provided you are willing to take a touch more risk (now there’s a big subject to cover), then corporate bond funds may be for you. They can be included in the stocks & shares component of an ISA, too.

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