Page 25 - DIY Investor Magazine Issue 24

investing for income; unfortunately issuance was scarce and some were lured by the siren call of unregulated mini-bonds to their great cost. See Retail Bond Expert
WHAT IS YIELD?
Whereas shares are quoted on the basis of price, bonds are bought and sold on the basis of their ‘yield’.
Bonds are issued at ‘par’, or 100% of their face value, and assuming the issuer doesn’t go bust they are also redeemed at face value.
The rate of interest paid by the bond is set when it is issued so the yield is that rate of interest relative to the bond’s price in the market; most bonds trade either above or below ‘par’ for most of their lives as markets rise and fall.
If a bond with an interest rate of 5% is trading at ‘par’, its yield is 5%; if the bond trades below ‘par’, the interest rate will be more than 5%, and if it trades above ‘par’ the interest rate will be below 5%.
There has been increasing demand for bonds over
the last couple of decades, which has meant that the interest rates companies have paid to issue bonds has decreased; it has also meant that yields on bonds have reduced as more people compete to buy them, forcing prices up.
In most instances, the longer the period to maturity, the greater the return on the bond, which is compensation for the risk posed by the longer holding period; today, gilts which pay out after just a month offer a yield of 0.21% whilst those with a 20-year term offer 0.64%.
Price volatility also tends to be higher on longer-dated bonds.
Particularly for government debt the lifespan can be very long indeed; gilts come in three main maturity dates – 0-7 years, 7-15 years and 15 years or more, with some in excess of 50 years
WHAT ARE THE PROS AND CONS OF BONDS?
A key advantage of bonds compared with shares is that if a company goes bust shareholders could lose all of their investment as shares only entitle you to a share of the profits; bonds are a claim on a company’s assets instead.
If the company goes bust bondholders have a chance of getting something back, although they rank below the banks and trade creditors in terms of being paid, and the type of bond you hold determines how much of your money you might get back.
Another advantage of bonds is that they tend to be less volatile than shares, although the trade-off is that over the long term shares perform better.
For DIY investors, investing in individual government and corporate bonds is not as straightforward as shares; most investment platforms require you to trade bonds over the phone rather than online and corporate bonds often have to be traded in denominations of £10,000 or more and are typically harder to sell than shares. Alternatives are provided by funds and investment trusts which invest in fixed income and exchange-traded funds (ETF) which track different baskets of bonds; these have the advantage of providing diversification too.
For those investing for income, bonds are likely to be a cornerstone of their portfolio; there is an ‘age-old’ rule of thumb which states that income investors should hold a proportion of bonds in line with their age -aged 30, 30% of your portfolio should be in bonds whilst at 60, it should be 60%.
For more about fixed income visit DIY Investor.
25 DIY Investor Magazine | Apr 2020