Retail bonds explained - Investment Guides from The Share Centre

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Retail bonds explained

What is a retail bond?

Investing in a company’s bond is a lower risk alternative to owning its equity (share). It promises a regular annual payment and the return of your capital at the end of the term. Investors can sell their bond holdings in the meantime, but the value will fluctuate according to other investors’ appetites.

The retail bond market remains relatively small, but is likely to grow as issuers look to tap into current market conditions (as savers continue to be disappointed with what’s available on the high street). Issues are likely to be in the form of index linked bonds (pay interest above the rate of inflation) or conventional bonds (pays a fixed rate of interest).

What are the benefits?

Bonds are not without risk when compared to cash savings/deposits, but they do offer an annual rate of income. If you buy them at issue and hold them to maturity, you’ll get your original investment back. 

The benefit of owning an index linked bond is that you get a real rate of interest after inflation.  However, should inflation turn to deflation, the interest payable could reduce. If you own the conventional bond, the interest received would not fall, even if inflation was to. So a conventional bond provides a regular known level of income annually. This means you can be certain to meet your outgoings, which is convenient if your expenditure rarely changes. If your expenditure fluctuates, for example if your outgoings are tied to utility prices, an index linked bond may be preferable.

The benefit of owning a bond over the company’s share is that you always get paid before the shareholder in the event of the company going bankrupt. Owning the equity might offer a better real rate of return, but it is impossible to know.

What are the risks?

Bonds available to the retail investor are not like savings accounts. Investors do not have the protection of the Financial Services Compensation Scheme and should the company go bust, capital could be lost. 

The credit risk on Gilts is very low as they are backed by the government. Corporate bonds are slightly riskier. The companies issuing them could default on the payments if they can't pay the bond coupon. There is also market risk to be aware of, as the trading price of bonds fluctuates according to the balance of supply and demand.

Inflation is an enemy of bonds, because rising prices erode the value of the fixed income they pay. That's compounded by the fact that interest rates are usually raised to control inflation. Rising savings interest rates make the fixed income from bonds less attractive, so they can lose value.

How do you invest?

You can purchase bonds through The Share Centre. Most bonds can also be invested in an ISA, where we’ll reclaim any tax deducted at source on your behalf. 

The alternatives?

If you wanted to go a step further and are comfortable taking on more risk, investing in company shares may provide an alternative. Equity income has the potential to pay a growing level of annual income with the potential of achieving a capital gain from your investment. The downside is the income payable comes with no guarantee.