Megan is a senior researcher and writer at Which?, with a background in data analysis and stats in the public and charity sectors.
Fixed-income investments are generally considered the next step up from cash, while also thought to be less risky than shares.
They are designed to pay you a steady income (though it's not always guaranteed) and tend not to offer as much opportunity for capital growth.
A bond is effectively a way of lending money to companies or governments. In return, they pay you a regular income in the form of interest for a set period of time, after which they must repay your loan.
The easiest way to access bonds is through funds, though you'll have to pay some additional fees for the convenience.
Here, we explain how bonds work, what kind of returns they might offer you, the risks you might encounter, how to invest and what role fixed income assets might play in your investment portfolio.
A conventional UK gilt might look like this:
3% Treasury stock 2030
Here's what the various elements mean:
If you buy £1,000-worth of Treasury stock 2% 2036 gilts, you would receive 2%, or £20, every year until your £1,000 loan is repaid in 2036. The income you receive is called the 'income yield', 'running yield' or 'interest yield' and is paid twice a year (1% or £10 every six months, in this instance).
The coupon rate is determined by the length of time you must wait for maturity and/or the riskiness of the company within which you invest.
The further away the redemption date, the higher the interest you will receive, as you are having to wait longer to be repaid. Similarly, the greater the risk you take on a company, the higher the interest rate you can expect to receive.
Unlike shares, they don't give you a stake in the company, but make you a creditor, ranking above shareholders in the pecking order if the company becomes insolvent.
You may not get your full investment back in the case of insolvency – only a proportion of the assets that are left.
You're not covered by the Financial Services Compensation Scheme, so it is important to assess the strength of the business you are lending to.
The redemption yield is a rate of return that combines the interest rate you get based on the price at which you buy the gilt, government bond or corporate bond, and the profit or loss you get if you hold the bond to maturity.
If you bought a gilt, government bond or corporate bond at a price that's lower than the launch price (£100), the redemption yield will be higher than the running yield, as you're set to make a profit when the bond matures.
Conversely, if you bought a gilt, government bond or corporate bond at a price that's higher than the launch price (£100), the redemption yield will be lower than the running yield, as you'll make a loss if you hold the bond to maturity.
Gilts, government bonds and corporate bonds are given credit ratings by companies, such as Standard and Poor's, and Moody's.
Bonds with a high rating – anything from AAA down to BBB – are deemed to be 'investment-grade', lower-risk bonds.
On the corporate side, these ratings are usually given to financially robust institutions, such as utility companies and supermarkets.
On the other hand, 'high-yield' bonds, sometimes known as 'junk bonds', are issued by companies deemed to be at greater risk of being unable to pay back their debt ('defaulting').
In order to attract investors to take on added risk, they offer much higher rates of interest. These companies will carry a rating of BB or lower.
This table shows the Standard and Poor's ratings on gilts, government bond and corporate bonds, along with what they can tell you about the health of a particular company or government bond.
| Fixed income credit ratings explained | ||
|---|---|---|
| Rating | Grade | Riskiness |
| AAA | Investment Grade | Highest quality – lowest likelihood of default |
| AA | Investment Grade | High quality – very low likelihood of default |
| A | Investment Grade | Strong – low likelihood of default |
| BBB | Investment Grade | Medium grade – medium likelihood of default |
| BB, B | High Yield | Speculative - high risk of default – |
| CCC, CC, C | High Yield | Highly speculative – high risk of default |
| D | High Yield | Default - unable to pay back debt – |
Getting to grips with the issuer of a bond and its rating is key to understanding how you can make money from bonds.
Our money guidance team can’t tell you what to invest in – but they can explain how to get started and make your own well-informed decisions. Unlimited access to them via phone is included in the Which? Money subscription.
Find out moreBond funds are collective investments, such as unit trusts or open-ended investment companies (Oeics). These funds pool your money with other investors' and invest it in a broad range of gilts or bonds.
Unlike direct investment, there is no maturity date with bond funds. The manager invests in dozens, or even hundreds or different bonds or gilts.
By investing in multiple bonds within a fund, you are able to spread risk. You can expect to pay an annual charge of anything between 0.1% and 1% for investing through a corporate bond or gilt fund. You'll generally pay less in fees for a passive bond fund.
You can buy UK government gilts directly from the UK Government's Debt Management Office (DMO). However, to buy directly from the DMO you need to apply to join an approved member list.
You can buy corporate bonds from the London Stock Exchange's Retail Bond Platform. They require a minimum investment of £1,000.
You can also buy gilts and corporate bonds through a stockbroker or investment platform.
Most gilts, government bonds and corporate bonds are traded on a secondary market, and their value can fluctuate based upon interest rates and the solvency of the issuer.
Bond prices will rise when general interest rates are low, because the rates of interest they pay are fixed and will beat the short-term rates available from banks.
Therefore, you may buy a bond or gilt for an amount above or below its original value (nominal value), and this will have an impact on both how much interest you receive as an income and the amount of money you will receive when the bond matures.
It works like this:
This guide is part of a series on asset types, ranging from cash to equity funds and share picking