Bonds are viewed as a relatively low-risk investment that can add stability to your portfolio, particularly compared to stocks.
So, what are bonds, how do you invest in them, and how much of your portfolio should they make up?
Bonds are a way for governments or businesses to borrow money from investors - usually at a fixed rate of interest.
When you buy a bond, you're effectively lending money to the bond issuer for a fixed period, known as the term.
The rate of interest is known as the coupon. Bonds offer a stable income on your investment for the duration of the term, with interest typically paid twice a year.
There are 2 main types of bonds:
The coupon will depend on the quality of the issuer, the duration of the bond and interest rates at the time the bond is issued.
For example, governments and large, well-established companies may be seen as 'higher-quality' issuers than smaller, less-established companies, as the risk of them not being able to repay investors is lower. So the coupon they offer may also be lower.
Once issued, bondholders can own a bond until it reaches its maturity date, when they get back the money they invested.
But bonds can also be traded on the secondary market. There, the market value of a bond can go up and down depending on how attractive it is to prospective investors.
A key measure of bonds on the secondary market is their yield. A bond yield is the amount of interest a prospective investor would earn, taking into account the bond's market value:
Coupon ÷ current price = yield
If interest rates have fallen, or are expected to fall, since a bond was issued, demand for the bond may increase, as its coupon appears more attractive. This can push up the value of the bond. But when the value of a bond goes up, its yield goes down.
If interest rates have risen, or are expected to rise, since a bond was issued, demand for them may fall, as the coupon may seem less attractive. This can push the value of the bond down, and its yield up.
| Pros | Cons |
|---|---|
| Tend to make slow, steady returns and reduce overall risk in a portfolio | If the bond issuer goes bust, investors may not get their money back |
| Typically have a fixed term | Secondary market bond prices can be harder to track than other assets, like equities |
| Regular, predictable interest payments | Potential returns may be lower than other assets |
| Available with a variety of maturities, from short-dated, 3, 6 or 12-month bonds, known as 'bills', up to 50-year bonds | In a rising interest-rate environment, bonds are unlikely to go up in value |
| Pros | Tend to make slow, steady returns and reduce overall risk in a portfolio | Tend to make slow, steady returns and reduce overall risk in a portfolio |
|---|---|---|
| Cons | If the bond issuer goes bust, investors may not get their money back | If the bond issuer goes bust, investors may not get their money back |
| Pros | Typically have a fixed term | Typically have a fixed term |
| Cons | Secondary market bond prices can be harder to track than other assets, like equities | Secondary market bond prices can be harder to track than other assets, like equities |
| Pros | Regular, predictable interest payments | Regular, predictable interest payments |
| Cons | Potential returns may be lower than other assets | Potential returns may be lower than other assets |
| Pros | Available with a variety of maturities, from short-dated, 3, 6 or 12-month bonds, known as 'bills', up to 50-year bonds | Available with a variety of maturities, from short-dated, 3, 6 or 12-month bonds, known as 'bills', up to 50-year bonds |
| Cons | In a rising interest-rate environment, bonds are unlikely to go up in value | In a rising interest-rate environment, bonds are unlikely to go up in value |
There are several ways you can invest in bonds, including through an online broker.
The easiest way to invest is through a fund. Bond funds pool together the money of multiple investors, which is then handled by a fund manager.
Funds help you to diversify your investments and spread risk, as they tend to consist of a variety of bonds.
The more bonds in the mix, the lower your risk, and the higher the proportion of equities, the higher your risk - and potential reward.
You can also choose to invest in an active or passive fund.
Active funds are managed on your behalf by a fund manager and typically have higher costs and fees than passive funds, which track the performance of a particular index.
If you're interested in buying bonds in the UAE, discover our fixed income bonds.
Before making any kind of investment, consider your current financial position, and set aside an emergency fund of 3-6 months' salary to cover any unforeseen expenses.
Think about your goals, how long you want to invest for, and how much risk you're comfortable taking.
Consider the different types of investment - whether you want to actively manage your own portfolio or pay higher fees for investment expertise.
Finally, decide how you want to invest, be it using an online trading app, setting up an investment account online, or speaking to an investment specialist, who can set up an investment account on your behalf.
And consider seeking independent financial advice before investing.
