29 December 2014

Bonds in your Investment Portfolio

The make-up of a good portfolio can be confusing if your only prior experience is with interest-paying savings accounts. But bonds would normally form a part of most people's balanced portfolio. So what are they?

We're not talking about savings bonds here - they typically pay a fixed rate for a fixed period of time. Nor are we talking about insurance bonds - they are investment products issued by insurance companies and are more of a "tax wrapper" than an investment themselves.

We are talking about fixed interest investments, where a body - typically a government or a company - issue a bond for a fixed term which investors buy. The issuer pays a fixed interest to the investor (hence "fixed interest"), and at the end of the term repays the original value in full. Most retail investors will use fixed interest funds rather than buying a bond directly, so there is no end date since the fund manager will buy another issue when one matures.

There are different types of bond fund, including "gilts" issued by the government, "investment grade" where corporate bonds are issued by more reliable issuers with good credit ratings, and "high yield" bond funds which contain bonds from smaller issuers who are less reliable and so have to offer a higher interest rate to offset that risk.

The enemy of all fixed interest funds is inflation. If you are receiving a fixed percentage from your bond investment but inflation goes up, that fixed percentage is immediately worth less to you, so the market value of that bond goes down.

Rather than managing the inflation threat yourself, an option I often advocate is to buy "strategic bond" funds. These allow the fund manager to invest in a mix of fixed interest investment which can change over time to suit current circumstances.

As always, seek financial advice to find what is appropriate to your circumstances.

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