The financial industry considers government bonds one of the safest assets you can invest in. They are backed by HM Treasury, and there’s little risk of the government defaulting on its debt.
When you buy a government bond, you’re essentially lending money to the government. In return, they’re giving you a bond with the guarantee they’ll pay you back, with interest. The government can always raise taxes to generate more money if it finds itself in financial difficulty, which means bonds are a relatively safe investment.
Along with stocks, mutual funds, and exchange-traded funds (ETFs), bonds are a popular investment vehicle for individual investors, mainly because of their dependability.
Who issues bonds?
A bond has three distinguishing elements that buyers should pay attention to:
- Who is the issuer of the bond (who are you lending your money to)?
- Are the bonds secured?
- What is the timing of the payment?
Government bonds are not the only bonds available to investors. Companies and even individuals can issue bonds. Corporate bonds are those issued by companies. Although individuals can issue bonds, these are very risky investments. Premium bonds are a savings product, also backed by HM Treasury, but different to the government or corporate bonds discussed here.
Sovereign bonds are the bonds issued by foreign governments. Their level of risk depends on the issuing government. An emerging market government bond is likely to carry more risk than a US government bond.
When an asset has been pledged as collateral to the bond, then it is a secured bond. For example, a building or other asset may be used to back a corporate bond.
Unsecured bonds are not backed by any kind of collateral. Here the buyer is likely to recover less than they initially invested if the issuer defaults.
Bond maturity is when the final payment is due on the bond. Bonds can vary in length of maturity from 1 day to 30 years.
Bonds vs stocks
Normally, the minimum amount required to invest in a bond is large. It requires less capital to buy shares in the stock market than to buy bonds.
Companies sell bonds directly to the public because they offer a relatively cheap way to borrow. Investors like this because the interest is usually higher than a savings account.
The amount of interest that a bond pays is its coupon. Bonds pay interest regularly, such as every six months. At maturity, the bond issuer repays the face value of the bond.
You can buy bonds directly from the issuer, or you can buy them on the open market through a broker. You’ll incur additional fees when buying through a broker.
Investors often sell bonds early if they expect interest rates to rise or if they need the cash. A zero-coupon bond offers no interest but is generally sold at a discount to its face value. So, the sum you receive at maturity is usually a good deal more than you paid.
The UK has experienced considerable political uncertainty in recent years. This has increased the demand for bonds, pushing their price up and the interest they pay down.
The recent Conservative election win has since brought a semblance of calm, renewing faith in stock market investing. With bonds now at historically high prices, I think the stock market has more appeal.
Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.