Are bonds a good investment? | Loyalty Britain (2024)

If you want to brush up on your knowledge of bonds, here's a quick refresher course. Otherwise, let's jump straight into the issue of investing in bonds.

• What are bonds?
• What influences bond prices?
  

Why has investor confidence in bonds fallen recently?

Many investors prefer the proven 60% stocks and 40% bonds in their portfolio. And that's because these two asset classes normally (note the word normally) perform differently under the same economic conditions. This has historically been useful when markets are volatile.

However, 2022 has been a particularly challenging year for both bonds and equities. This led many investors to question the traditional 60/40 split and question the weighting of their portfolios.

How have bonds performed in 2023?

Interest rates have been higher than anyone expected for longer. And this is largely because inflation, while falling, has not fallen as quickly as people had hoped. The government's target of 2% has also not been achieved.

According to my colleague, Ed Monk, i,“That means a lot of people who have lost on bonds in recent years are left with those losses and hopefully waiting for a recovery and a return in interest rates — looking for things that will cause that.” But he goes on to explain: “It's probably worth saying that what we saw immediately prior to this period was incredibly high bond prices and incredibly low interest rates... getting back to that is much less certain. We may see a partial reversal – But a return to that level may never happen.”

Are bonds a good investment?

This was actually a question that came up in October. Here's what Tom had to say when wondering if it's a good time to buy bonds or a bond fund.

“I think it is a good time to invest in bonds. Because interest rates have now risen to a level where you can lock in a pretty attractive return (or income) on your bonds, perhaps as high as 5% (which is about the same as what you can get with cash). And if interest rates start to fall and bond yields follow them, I think we'll see some potential for capital gains as well. Because bond yields and bond prices move in opposite directions. As interest rates fall, the price of bonds will rise... so you're securing a good income and you have the potential for capital gains.”

As for whether now is a good time for corporate bonds or government bonds (called gilts in the UK), Tom believes that the balance between risk and return is heavily skewed towards investing in government bonds, which are the most sensitive form part of the interest rate universe. on movements in interest rates. The chance that interest rates will fall from current levels is greater than the chance that they will rise much further.

If you're wondering why he's not in favor of corporate bonds, it's because those bonds are also affected by the health of the economy and its impact on businesses. As the economy slows, more of these countries may find themselves in trouble and unable to meet their obligations to lenders. This is likely to become a bigger problem as more companies need to refinance their debt at much higher rates.

For this reason, investors looking for the additional income that corporate bonds offer compared to government bonds should err on the side of caution and invest only in the highest quality corporate bonds. So-called high-yield bonds may look attractive based on the income they offer, but the risk of bankruptcy is correspondingly higher.

The short video below from Tom highlights the role that government bonds can play in your portfolio.

Government bonds listed on the Select 50

If you're looking to diversify your portfolio by owning a share of government bonds, I've listed below the bond funds that make up the Select 50 (our favorite funds chosen by experts). We currently have five on the list. Take the time to read the fund's fact sheet before investing. In the table you will find links to each fund. And investment writer Nick Sudbury takes a closer lookiShares Overseas Government Bond Index Fund haar.

What are bonds?

Bonds are a debt-based investment. Consider them IOUs. When you buy a bond, you are essentially lending money to a government (also called government bonds in Britain or government bonds in America) or to a company (corporate bonds) for a fixed period. At the end of this fixed period, the bond matures and the starting capital is repaid. In addition, the borrower pays you as a lender an annual fixed interest rate, also called a coupon.

Some bonds have a short term and mature within five years, usually one to three years. Because these pose less inflation and default risks, they typically receive a lower interest rate (or return/income). And some are long-term bonds, which often earn higher interest rates.

It is worth noting that interest rates on short-term bonds can sometimes be higher than on longer-term bonds. This usually happens when central banks aggressively raise interest rates and can be an indication of an economic slowdown or recession ahead. This situation is known as an 'inverted yield curve'.

What influences bond prices?

The price of a bond is mainly influenced by three things.

• Supply and demand -when supply is high, price is low and vice versa.
• Playing time -As the maturity date approaches, the price of the bond will naturally move towards the value the investor paid for it (in other words, the borrower pays back the investor's note - which in Britain is always £100) . This is known as face value. Over the life of a bond, its price will be higher or lower than its face value of £100, depending on whether the yield to maturity (the total expected return on a bond if the bond is held to maturity) is higher or lower than the value of the bond. applicable interest rate.
• Credit quality -corporate bonds tend to offer higher interest rates, also called yields, because they are riskier than government bonds (since governments don't collapse often). Investors demand higher interest rates to compensate for the greater risk.

But there are also all kinds of other secondary influences that influence bond prices, such as:

• Tenant -Imagine if bonds and interest rates were on opposite sides of a seesaw. When interest rates rise, bond prices fall. And when interest rates fall, bond prices rise. They generally move in opposite directions. Short-term bonds are less exposed to interest rate risk.
• Inflation -One of the biggest threats facing bonds is inflation. As prices rise, they erode the value of the fixed interest payments you receive on a bond. If you're earning 3% interest on a bond, but inflation is at 6.7% (as the September figures revealed this week, unchanged from August levels), you're actually losing money in 'real', for inflation-adjusted terms. Long-term bonds are more exposed to inflation.
• Other factors such as taxes or salary -these all indirectly affect bond prices because they influence the decision-making process of investors. This has a knock-on effect on supply and demand, which in turn affects bond prices.

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