What are Bonds? How do you Buy Bonds in the UK?
Experienced investors will often combine traditional stocks with bonds, as it allows them to diversify into other markets. Crucially, bonds allow you to earn a fixed amount of income until they mature, so you always know exactly how much you are likely to make. On the flip side, your initial investment will be tied-up for a number of years – so they won’t suit all investors.
In this guide, we explain the ins and outs of what bonds are, how much you should expect to make, and whether or not they are likely to be suitable for your long-term investing goals.
What are Bonds?
Bonds are issued by large companies and governments as a way to raise capital. As a buyer of bonds, you are effectively loaning the money to the respective institution. In return, you will be paid a fixed rate of income – which is known as a ‘coupon payment’.
The value of each coupon payment will never change, and it is dependent on a vast number of factors. For example, if the bonds were issued by the UK government (these are called ‘Gilts’), then you will likely receive a very low yield of between 0.5% and 1.5% per year.
This is because the only way that you would lose your money is if the UK government no longer existed! At the other end of the spectrum, bonds issued by large companies such as BP or HSBC will pay a much higher rate. After all, companies do not have the backing of a central bank – so there is every possibility that there will run into financial difficulties and thus – be unable to pay you back.
The coupon payment will be distributed every 3 or 6 six months until the bonds mature. This is a pre-defined date that is usually a number of years ahead of when the bonds were issued. When the bonds do mature, this is when you will receive your original investment back (known as the ‘principle’). As such, you will need to be comfortable with leaving your investment ‘locked-up’ for several years, as rarely can you access the money before the maturity date.
Bonds vs Investing in Shares
How do Bonds Work?
The bond investment process is actually very straight forward. This is because once the investment had been made – you don’t need to do anything else until they mature. As such, this is passive income in its truest form. Before we get to that, let us explain the bond investment process is Layman’s terms.
First and foremost, bonds are issued by companies as a means to raise money. For example, let’s suppose that Royal Mail needs to raise some cash to fund a new international venture.
Generally speaking, Royal Mail would have the following options:
- Borrow the funds from a large-scale financial institution
- Issue more shares – which would dilute the value of the stocks for current shareholders
- Sell some of its assets
- Issue bonds
By issuing bonds, Royal Mail is effectively borrowing the money from the wider markets – as opposed to taking out financing from a single institution.
The tricky part for companies that issue shares is determining what rate of interest they should pay to bondholders. If the rate is too low, then outside investors (such as you) will not be interested. If the rate is too high, then the company will be paying more interest than it needs to. To help companies ascertain what yield to offer, they will seek consultancy services from a third-party.
Nevertheless, the amount of interest that the company offers will generally centre on metrics like:
- How long the company has been trading for
- The strength of the company’s balance sheet
- Operating profits and margins in comparison to the prior financial year
- The length of time that the company needs to borrow the funds for
- How much the company needs to raise
- The specific sector that the company operates in
To put the above in simple terms, a strong company like Facebook issuing bonds would likely command an interest rate in the 2-5% region. But, a relatively new company like Uber – which is yet to make a single penny in profit – will arguably need to pay significantly more.
Coupon Rate and Maturity
In Layman’s terms, the ‘coupon rate’ is the amount of interest that you will receive on your bond investment. This is always expressed as a percentage, and rarely will it change. This is why bonds are often called ‘fixed-rate’ bonds, as the coupon rate remains fixed until they mature.
So, in order to assess how much you are going to make form a bond investment – you need to multiple the coupon rate by the size of your investment.
- Let’s suppose that you buy Tesco bonds
- Each bond is worth £500 and you purchase 10. This takes your total investment to £5,000
- The coupon rate on the bonds is 5%
- This means that you will make £250 every year until the bonds mature
In terms of the bond maturity, this is simply the date that the bonds will expire. When they do, you will receive your original investment back in full.
- Sticking with the same example as above, you invested £5,000 into Tesco bonds
- We’ll say that you bought the bonds on January 1st 2020
- The bonds mature on January 1st 2025
- This means that you will receive £250 annually for five years – taking your total coupon payments to £1,250
- On January 1st 2025, you will then receive your original £5,000 investment back
As you can see from the above, as soon as you bought the bonds you knew exactly how much you were going to make, and the exact date that your money would be repaid. Once again, this is as passive as it gets in the online investment space!
Can I Sell my Bonds Early?
Yes and no. Ultimately, whether or not you can sell your bonds before the maturity date will depend on the type of bonds you are holding.
For example, if you are in possession of UK Gilts or US Treasuries (bonds issued by the respective government), then in most cases you can sell them at any given time on the secondary marketplace.
This is because UK and US government bonds are in high demand by the financial markets – so offloading is rarely an issue. But, this is on the proviso that your chosen broker allows you to do this, as not all do.
At the other end of the spectrum, offloading corporate bonds to the secondary market is not as easy – as liquidity levels are much lower. If you do have the means to sell the bonds earlier, it is important to note that you might not get the same price than you originally paid. This is because the ‘yield’ of the bonds can change from day-to-day.
What are Bond Yields?
Here’s where things get slightly more complex – as each bond investment will effectively have two different ‘rates’. This is the coupon rate – which we explained earlier, and then the bond yield. In a nutshell, while the coupon rate will never change, the yield will. The yield determines how much the bonds are worth in real-time – based on current market conditions.
- Let’s say that you bought £10,000 worth of Barclay’s bonds with a maturity of 7 years
- The coupon rate on the bonds is 3.5% – so you would expect £350 per year until they mature
- A few years into the bond agreement, Barclay’s runs into financial difficulties and it is forced to ask for a loan from the government
- As such, the chances of Barclays defaulting on your bond repayments increases.
- In turn, the yield on the bond will go up – say to 5%
This means that were you to sell the bonds on the secondary marketplace, you would need to sell them at a lower price than you originally paid. The reason for this is that new investors will want to be rewarded with a larger rate of interest to counter the higher risks. The only way for you to facilitate this is to offload the bonds at a ‘discount’.
Of course, were the opposite to happen – and Barclay’s outperformed market expectations, the yield on the bonds would go down, meaning that you could sell them on the secondary market at a ‘premium’.
Top Tip: If you plan to hold on to your bonds until they mature – the yield is effectively irrelevant. This is because the coupon rate will never change, so you will always receive the same amount irrespective of whether the yield goes up or down!
When do I get my Bond Payments?
In the vast majority of cases, companies will distribute bond payments every 3 or 6 months. Once the frequency rate has been ascertained, it will never change. In theory, the value of your investment will grow at a slightly faster pace if the bonds pay out quarterly, as you will have the opportunity to reinvest the payments into other ventures.
However, the difference will be minute unless you are looking to invest a substantial amount!
Either way, the coupon payments will be transferred from the company to the broker that you bought the bonds from, and then reflected in your account. You can then reinvest them into other revenue streams like stock trading, ETFs, mutual funds, or investment trusts – or simply withdraw them back to your UK bank account.
How Much Money Will I Make From a Bond Investment?
There is no one-size-fits-all answer to this, as it really does depend on the company (or government) that issues them. It will also depend on the length of the bond agreement, and financial health of the issuer.
While this doesn’t answer your question per-say, below we list a few examples of bonds that are currently active in the UK market.
Company Coupon Rate Maturity Yorkshire Building Society 13.50% 2025 Co-operative Group Ltd 11.00% 2025 Barclays Bank plc 9.50% 2021 GlaxoSmithKline Capital 5.25% 2033 Tesco 5.00% 2023 Severn Trent 1.30% 2022 National Grid 1.25% 2021
It is important to note that the figures above are based on the coupon rate, and not the yield. As we discussed earlier, the yield is what will dictate the price that you pay for the above bonds. That is to say, if the company has performed well since the bonds were issued, you will likely pay a premium. If the opposite has happened, you will most probably get a discount.
What are the Drawbacks of Investing in Bonds?
Bonds offer a number of benefits to the average investor. Whether its the passive nature of buying bonds or the safety-net of knowing exactly how much profit you are going to make – bonds tick a lot of boxes for the newbie investor.
However – and like all asset classes, there are a number of drawbacks that you need to take into account.
Inability to Access Your Money
As we briefly discussed earlier, it is often difficult for the average investor to offload bonds before they mature. This is because you won’t have direct access to the secondary bond market.
Crucially, while it’s not impossible to sell the bonds earlier, it can be challenging nonetheless. As a result, you should be prepared to lock your money away for a number of years until the maturity date comes to fruition.
With that being said, if you are looking for an investment stream that gives you rapid access to cash when you need it, you might want to buy shares instead. This is because you can sell your shares at the click of a button during standard market hours. When you do, the funds will be credited to your brokerage cash account, which you then withdraw out.
Difficult to Access
As we cover in more detail in the next section, getting your hands on bonds as a regular investor can be challenging. Firstly, when the respective company issues the bonds, they are normally purchased by large-scale institutions or brokers.
This is because the company will implement a minimum lot size – which is typically 6 or 7 figures. This is a much more efficient process for the company as opposed to selling them off individually to the retail client arena.
Once again, traditional shares are completely different – as you can open an account with a UK stock broker, deposit funds, and buy your chosen equities in a matter of minutes.
You Face the Risk of a Default
Much of this guide has focused on the passive, regular, and clear-sighted nature of bonds. By this, we mean that once you make an investment, you know exactly how much you are going to receive in coupon payments. You also know the date in which you will receive your original investment back.
However, like all investment classes, there is never any guarantee that things will go to plan. After all, when companies issue bonds, they are borrowing money from outside investors. This money must be repaid, so if the company runs into financial difficulties, there is always the chance of a default. If this does happen – you will lose money.
How to Invest in Bonds in the UK?
If you’ve read our guide up to this point, you might be attracted by the passive nature of bonds. After all, once you make a purchase, you can sit back and enjoy your quarterly or bi-annual coupon payments until the bonds mature. But, the main barrier that you will face as a retail investor is that bonds are super-difficult to obtain.
The good news is that you do have a number of options at your disposal – which we uncover in more detail below.
Option 1: Buy Bonds From Hargreaves Lansdown
When it comes to buying bonds in the traditional sense – one of the very few UK platforms that you will have at your disposal is Hargreaves Lansdown. In fact, the bond coupon rate examples that we discussed earlier were taken from the Hargreaves Lansdown website.
You will have a good select of bonds to choose from – which includes both corporate and government bonds. You will need to check what the ‘running yield’ on the bonds is, as this gives you a clear indication of the value of your investment.
In simple terms, the running yield looks at the difference between the coupon rate and the current price of bonds, so that you know how much money you are making on the investment.
To buy bonds from Hargreaves Lansdown you will need to:
- Open an account
- Deposit some funds with a UK debit card or bank account
- Make sure the meet the minimum investment amount (this differs from bond-to-bond)
- In most cases, you then need to call Hargeaves Lansdown to place your bond order (there are a few exceptions)
Once you buy the bonds, your coupon payments will be reflected in your Hargreaves Lansdown account. When the bonds mature, your original investment will also be paid into your brokerage account.
Option 2: Invest in a Bond ETF With eToro
The second option that you have at your disposal is to invest in a bond ETF. In its most basic form, a bond ETF will give you access to heaps of bonds through a single investment.
- The provider behind the ETF will subsequently buy and sell bonds on your behalf – meaning that you will still benefit from passive income.
- Bond ETFs are somewhat unique, as the provider will rarely hold on to its bond investment until maturity.
- Instead, it will look to actively trade the bonds on the secondary market – with the view of making regular gains.
- You will, however, still be entitled to coupon payments as and when they are paid.
- In most cases, the bond ETF will distribute your share of coupon payments every three months.
There are literally hundreds of bond ETFs active in the investment space, so you are best advised to think about the type of markets you wish to target. For example, while some bond ETFs will focus exclusively on low-risk government securities, others will target high-yield corporate bonds.
If this is something you do want to explore, it might be worth checking eToro out. The FCA-regulated broker allows you to invest in the best UK bond ETFs (as well as shares) on a commission-free basis, and the minimum threshold is just $50 (about £40).
Here’s what you need to do:
Step 1: Search for Your Preferred Bond ETF
Assuming you already have an account with eToro (if you don’t it takes just minutes to get started), your first port of call is to search for your preferred ETF. In our example, we are looking to invest in the ‘iShares US Corporate Bond ETF‘. As the name suggests, this is an ETF that buys and sells corporate bonds that are listed in the US.
Step 2: Click on the Trade Button
Next, click on the ‘Trade’ button to go straight to the bond ETF order page.
Step 3: Complete Order
To invest in your chosen bond ETF, all you need to do is enter the amount that you wish to stake. In our example, we are investing the minimum – which is $50 (£40). Finally, click on the ‘Open Trade’ button to complete your bond investment.
In summary, while most newbie investors choose to invest in stocks, it is also worth allocating a segment of your portfolio to bonds. This is because you will benefit from regular coupon payments until the bonds mature – and the entire investment process is 100% passive. But – and as we have discussed in this guide, buying bonds as an average investor can be challenging. We have, however, given you a few options to consider – so spend some time thinking about which one best meets your long-term investing goals!
Should I invest in bonds or shares?
This will ultimately depend on what your long-term investing goals are. If you are looking for a 100% passive income source and you want to know exactly how much you will earn, bonds might be suitable.
How do I buy UK government bonds?
If you want to buy UK government bonds (which are known as 'Gilts'), you can actually do this online via the UK Debt Management Office.
What yields do UK bonds pay?
This will vary by a considerable amount. For example, while high-grade bonds can pay less than 1% per year, junk bonds can pay double figures!
Are bonds safer than shares?
Once again, there are simply too many variables to consider. For example, UK Gilts are significantly safer than low-cap shares. At the same time, high-grade blue-chip stocks are much safer than low-grade corporate bonds!
How do I trade bond prices with real money?