MARKET COMMENT
How To Buy Bonds

By David Kuo (TMFDragon)
September 20, 2004

If you are interested in generating income from your investments, or perhaps just want to introduce some stability to your portfolio, then it is worthwhile considering bonds.

When you invest in a bond, you are essentially lending money to a company or government for a fixed rate of interest, known as the coupon. When the bond matures after the fixed period, you'll get back a redemption amount, known as the principal.

Bonds are not specifically designed to produce capital growth, though they sometimes can. In the 1990s, when interest rates were falling, bonds did very well indeed. This was because their fixed income streams became more valuable when rates fell. As a result, people were prepared to pay more for bonds.

Bond price movements can also reflect what investors think about the state of the economy. If bond prices rise, it could imply that experts reckon economic conditions are deteriorating. Conversely, if bond prices fall, it can mean the economy is improving. Last month, a combination of record oil prices and slowing domestic economies prompted investors to push up the price of bonds.

Investors who want to buy bonds can do so quite easily. Gilts, which are loans to the British Government, can be bought directly through the Bank of England or via a stockbroker. Corporate bonds, which are loans made to companies, can be bought through stockbrokers.

However, if you don't want to buy bonds directly, it is possible to choose from a variety of bond funds. These funds pool your money with those of other investors and invest in a portfolio of bonds. Some funds may also specialise in emerging market bonds or higher risk bonds known as junk bonds.

It is also possible to invest in bonds through iShares, which are Exchange Traded Funds, and these can be bought and sold in the same way as shares can. iShares can also be included in a Self-Invested Personal Pension or in a Self-Select ISA. The advantage of including them in an ISA is that any capital growth and dividend income will be tax-free!

There are currently three different iShares that UK bond investors can invest in. These are iBoxx € Liquid Corporates Fund (LSE: IBCX), which tracks the performance of the Euro corporate bond market, iBoxx Sterling Corporate Bond Fund (LSE: SLXX), which tracks the UK corporate bond market, and iShares Goldman Sachs $ InvesTop Corporate Bond (LSE: LQDE) that follows the dollar denominated corporate bond market.

Personally, I do not believe economic conditions are deteriorating, and nor do I believe interest rates are likely to fall as a result in the near future. However, bonds are intended to generate a steady stream of cash, which can be attractive for people who are after income from their investments. That said the price for that safety is likely be lower returns over the long term compared to shares.

Find out more about bonds and Self-Select ISAs.