Companies and governments borrow money through bonds. This allows these organisations to raise capital through investors. In exchange for money, the organisation will typically promise to pay back the investment made plus interest over a certain amount of time. The duration of a bond can be short, medium or long-term, but it’s usually for a number of years.
When investing through bonds, the investor is essentially lending a government or company money. In exchange for giving them cash, the investor regularly earns a fixed rate of interest. When the bond’s life comes to an end and reaches its maturity, the original cash put in should be repaid.
For investors, there are two ways to earn money through bonds. Investors can hold onto the bonds until the maturity date, collecting interest payments. Interest from bonds is typically paid twice a year. Investors can also sell bonds at a price higher than what was initially paid if the market conditions allow.
The best way to invest in bonds
Bond investments are best when investors have a lump sum to invest. They are often traded more during uncertain times. Bond prices often change when interest rates change. For example, when interest rates are low, bond prices typically increase.
Bond prices can also increase if the borrower’s credit risk profile improves. This means the company or government is more likely to be able to repay the bond at maturity, which typically causes bond prices to increase. Additionally, if interest rates on newly issued bonds fall, the value of existing bonds usually rise to a higher rate.
The risk involved with bonds
The risk level of bonds is considered to be between cash savings and shares. Bonds tend to be less volatile than shares and can potentially offer a steady income stream. However, it’s important to keep in mind that bonds can still fall in value.
The predominant risk with investing in bonds is that the organisation you’ve given money to could run into financial trouble. This could lead them to not being able to meet their interest payment obligations, and if the business goes under, you could lose all of the money you gave them.
Savings bonds, which are typically fixed term bank and building society accounts, are different to these kinds of bonds. Savings bonds are covered by the Financial Services Compensation Scheme in the UK, while government and corporate bonds are not.
When a company goes bust, bonds offer more protection to investors when it comes to getting their money back than shareholders. Bondholders have preferential treatment to be paid before shareholders, who receive only what is left after all creditors have been paid, but your investment isn’t guaranteed if the company goes into liquidation as there may be no money left to pay bond investors.
It’s recommended to receive professional financial advice when considering any kind of investment to ensure you find the best investment option for you.