What is a Bond?
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It’s simply a loan. You lend your money to a company, or government, and as a ‘thank you’ they pay you interest.
Why would they borrow from me?
In the same way that we need loans to buy a new house or new car, companies and governments need loans to pay for new projects. The amount they need may be too large for a bank to lend so they borrow from the public.
How does it work?
Instead of asking for a very large amount of money the government or company divides the loan into smaller, equal portions and investors are invited to lend each portion. In return for parting with their money, investors are paid yearly interest until the loan is repaid.
Gimme an example…
Say John Lewis wants to build a new store on Oxford Street and they need a £100 million, five-year loan to do this. They break down this large sum of money into blocks of £1000 (that’s 100,000 blocks) and advertise these to investors. Investors can buy (or lend) one or more blocks and will receive interest over the next five-years for this.
Will I earn a lot from bonds?
This depends on the interest rate advertised by the company at the start. If, for example, 6% interest is advertised and you lend £10,000 you'll receive £600 a year until the loan term comes to an end (aka matures).
What about being taxed on my earnings?
Any interest you earn from bonds is taxed as income. However, there's a tax break called the personal saving allowance (PSA) where basic-rate tax payers can earn £1,000 interest a year tax free and higher-rate tax payers can earn £500 a year.
If you're earning more interest than this each tax year then open a Stocks & Shares ISA and buy bonds through this. Any gains made through an ISA are tax-free but yearly deposits are limited.
Ok, so are all bonds the same?
Nope. There are different types of bonds. Here are the most common ones…
Corporate bonds… you lend to a company.
Retail bonds… you lend to a company but the minimum loan amount is smaller (usually it starts at £1,000).
Government bonds… you lend to a government, which could be anywhere in the world. UK government bonds are called gilts. MOXI Tip: Developed country’s bonds tend to pay less interest but are a safer investment.
Local Government Authority bonds… you lend to local governments such as the UK’s borough councils. Again, they’re a safer bet but pay less.
I’m confused by the lingo. Please help!
The total money a company wants to borrow is broken down into equal blocks, these blocks are called ‘bonds’ and when you buy a bond you are lending a block of money.
The ‘maturity date’ is the date the company will pay back the loan.
The 'coupon' is the yearly interest paid to a bond holder.
Lastly, bonds are called ‘fixed income’ investments because each year you earn a fixed amount of income (although some bonds offer variable interest rates).
