SAVINGS & INVESTMENTS

Fixed Interest Investments

IOUs issued by governments and businesses

Fixed Interest Investments

Fixed interest investments, more commonly known as bonds, represent loans made by investors to governments or companies. It is important not to confuse these with investment bonds, which are insurance-based products and operate very differently.

When you buy a bond, you are effectively lending money to the issuer. In exchange, the issuer agrees to pay you a predetermined level of interest, called the coupon, over an agreed timeframe. At the end of that term, known as the maturity date, the original amount you invested is repaid.

Although the coupon payments are set in advance, bonds themselves can be bought and sold on secondary markets. This means their market value can rise or fall before maturity, depending on economic conditions and investor demand.

Key risks to understand

While bonds are often considered more stable than shares, they are not risk-free. Several factors can influence their value and reliability.

Credit Risk: This is the possibility that the issuer fails to make interest payments or cannot return the capital at maturity. Credit rating agencies assess this risk and assign ratings to governments and companies. Higher-rated issuers are considered more reliable, while lower-rated issuers carry greater risk.
Interest Rate Risk: Bond prices tend to move in the opposite direction to interest rates. When interest rates rise, new bonds are issued with higher coupons, which can reduce the appeal of older bonds paying lower interest. As a result, the price of existing bonds often falls. A bond’s duration gives an indication of how sensitive it is to changes in interest rates.
Inflation Risk: Because coupon payments are fixed, rising inflation can erode their real value. If inflation increases faster than the income a bond provides, the purchasing power of both the income and the capital repayment may decline.

How bonds fit into a portfolio

How bonds fit into a portfolio
Fixed interest investments are often used to balance a portfolio. They can provide a predictable income stream, tend to fluctuate less than equities, and are generally easy to buy or sell. However, they still carry risks and should be selected carefully as part of a broader investment strategy.

Types of fixed interest investments:

Government bonds: Governments issue bonds to fund public spending. In the UK, these are known as gilts. Because the UK government has a strong credit standing, gilts are widely viewed as lower-risk investments. This lower risk usually means lower yields compared to bonds issued by companies.
Investment-grade corporate bonds: These bonds are issued by financially stable companies with strong credit ratings. While they carry more risk than government bonds, they are still considered relatively defensive investments. To compensate for the additional risk, they generally offer higher interest payments. Credit ratings can change over time if a company’s financial position improves or deteriorates.
High-yield (sub-investment grade) bonds: Often referred to as high-yield or junk bonds, these are issued by companies with weaker credit profiles. They offer much higher coupons to reflect the increased likelihood of default. These bonds are typically used by investors seeking higher income or growth potential, rather than capital preservation.

Pricing, access, and charges

Individual bonds are usually traded over the counter between institutions, while bond funds are priced and traded daily. All fixed interest investments involve costs, whether through dealing spreads on individual bonds or ongoing charges within funds. These costs reduce overall returns.

For tax efficiency, bonds and bond funds can be held within tax-advantaged wrappers such as ISAs or pensions, helping to shelter income and gains from UK tax.