Jajhar Singh·

8 min read

We all should have financial goals in some shape or form. Such goals will look different to different people depending on their life stages. The goals of a pensioner will be different to those of a couple with a young child. The goal for a young adult just finishing education will be different to that of a single parent raising a family of teenagers. One common goal that all should have is the pursuit of financial freedom.

Working hard and honestly for your money is not enough to obtain that goal of financial freedom. Alternative vehicles are required to aid you to meet your financial goal. Investment is one of those vehicles. The investment vehicle itself comes in different shapes and sizes. You can choose from between the most recent trend of digital currency investment to Real Estate. This article will discuss and give you a good grounding on the idea of investing and more specifically targeted towards explaining Bond Investments.

One of the significant impact on your wealth is inflation. Inflation is a measure of the rate in the increase of the price of goods and services. We saw the after effects on the world economy following Covid-19 and the war in Ukraine affected the supply of goods. That resulted in an increase in price of goods meaning that inflation had shot up to circa 11.1% in October 2022. The impact of inflation on your personal wealth is that your personal wealth gets eroded. Your £10,000 savings is not going to be worth £10,000 in ten years.

The traditional method of wealth building was to accumulate earnings from your job or business. You would get paid a wage or income and you would use it to pay for your living costs which include housing, food and clothing. Whatever was left over would go into a savings account and would accumulate in value.

Savings accounts tend to offer a higher interest rate. An interest rate is a percentage that the bank will pay you for using their bank to hold your money. This is the first example of your wealth compounding as a result of being paid interest. The interest rate offered by the bank is usually linked to the interest rate set by the central bank. It is usually a couple of percentage points higher than the national interest rate. The national interest rate is usually set depending on the economy. For example as we mentioned above when inflation skyrocketed in 2022, central banks throughout the globe had to increase interest rates to control inflation. To sum up here traditional bank savings accounts as vehicles are susceptible to factors such as interest rates and inflation.

An investment vehicle on the other hand works very differently to a savings account. With an investment, you are committing your money into a project to build something. You could also be purchasing a stake in a project with the expectation that the project will return a profit on your capital. In terms of how an investment behaves differently to a savings account the rate of return tends to be higher and in a shorter time frame. Investments are more riskier than traditional savings accounts but history has proved that the risk is manageable.

As already mentioned above, there are a number of investment vehicles that you can choose from depending on your expertise and risk threshold. It is always advisable to have a diverse investment portfolio. The more diverse the less risk you carry. As the saying goes “Don’t put all your eggs in one basket”.

One popular investment vehicle is the investment in Bonds. The rest of this article will focus on Bond Investing. A Bond essentially represents a loan from the issuer of the bond. The issuer may have a requirement for access to instant cash injection to complete a project as part of their overall activities. The Bondholder can provide that cash and gain a Bond in return. The Bondholder can also expect interest payments on the cash he or she has used to purchase the Bonds. The amount of interest is usually a percentage of the value of the Bonds. In this instance we can see similarities between a Bond and a traditional saving account. At the end of the agreed Bond term the issuer will return the full value of the Bond taken out by the Bondholder.

There are a variety of Bond types available and different circumstances in which they are issued. A common Bond is Government Bonds. The government may have a requirement to upgrade its infrastructure. An example of this would be the HS2 line. The government would issue Bonds to the general public to fund such a project. The UK government issues Gilt Bonds and the US issues Treasury Bonds. Away from the government we also have corporations who are looking to expand their operations to increase profitability. In order to fund those expansions they issue Corporate Bonds. Municipal Bonds are issued by states and cities to raise cash to run public projects. Lastly there are also convertible Bonds which are issued by corporations, but are converted into stocks for bond holders to own rather than returning their investment.

Bonds are established as a secure way of accumulating an annual yield on your investment. This provides a steady income to your finances which increases your wealth. In order to compound your growth, there is an option to reinvest your annual yield into purchasing additional bonds. This in turn increases your annual yield. Zero-Coupon Bonds have built in compounding. These products are offered at a discount rate and instead of getting paid an annual yield it purchases additional bonds. Other Bond products include Mutual Funds and Exchange Traded Funds(ETFs). These are provided by most financial houses and carry out the process of reinvesting annual yields back into your Bond investment.

The origins of Bond investing can be traced back as far as 2400 BC. Farmers in Mesopotamia would use debt instruments to borrow grain and other goods. These bonds would be in the form of notes that would be promissory. Promissory indicates that they were legally binding.

The Bank of England issued the first Government Bonds in 1694. This was to fund the war against France. This saw the introduction of Sovereign debt and created modern government bonds.

During the American Revolution between 1776 to 1790, The US government also issued war bonds. This led to the creation of the US Treasury. The US Treasury consolidated state debts into federal bonds.

Corporate bonds followed government bonds into existence. During the 19th century amidst the Industrial Revolution private companies grew exponentially through the issue of corporate bonds. It is at this point where Bond Investing really took off in popularity for the general public.

The financial boom in the 1980’s saw the emergence of Junk Bonds. These bonds were yielding higher than traditional bonds. It was a platform for riskier companies to be able to raise capital and change the landscape of fixed income investing.

Just like any kind of investing, bond investing carries its own set of risks that all investors should be aware of. The wider economic climate has an impact on the returns investors get from Bonds.

Firstly we have the risk around interest rates. As already mentioned above interest rates tend to be dictated by economists depending on the landscape of the economy. If the interest rates rise, bond prices fall making them more attractive. The newer bonds will yield higher rates while the older bonds will be valued lower. We recently saw this trend in 2022 with the rise of inflation and central banks around the world increased interest rates.

Another risk is the issuer of the bond defaulting. The issuer may not be able to pay your money back. The risk tends to be higher for corporate bonds as there is a possibility that the company goes bust. Government bonds on the other hand have a better credit rating and carry less risk.

At an economic level inflation and interest rates are linked with each other. Just as interest rates are a risk to bonds, so is inflation. The purchasing power of the bonds diminishes as a result of higher inflation as it erodes bond income.

During an unfavourable time in bond markets, selling bonds can prove to be a bit more difficult. This is particularly true of corporate and municipal bonds. This is known as a Liquidity Risk.

Also linked to interest rate risk is reinvestment risk. If you are reinvesting your bonds to compound you may have to reinvest at a lower interest rate which impacts your returns. The interest rates are set by the central bank of a given country.

Bond Investing is very popular amongst institutions such as Pension funds, Insurance companies and central banks. They hold large portfolios of bonds as bond investing guarantee’s fixed and stable returns.

If you are employed, chances are that you will have a company pension. Most pension schemes have a balanced mindset to investing in respect of risk. The balanced mindset means that a significant portion of your pension will be invested in bonds alongside stocks and shares which tend to be large cap. Stocks and Share investing is different to bond investing and will be discussed in a separate article.

Talking of pensions, upon retiring you are entitled to cash in your pension. Pensioners who get a regular income still want to invest that income so that their money continues to work hard for them. At this point in life retirees are more risk averse and therefore bond investing is a more attractive option for them.

Bond investing is a great alternative vehicle to the traditional savings account. Though reinvestment bond value can compound to yield a good return. Bond investing also provides a higher predictable income stream also.

Bond investing has been around for several centuries now and has evolved in different ways. There are a number of different kinds of bonds available such as government, municipal, corporate and junk. Each one carries its own risk weighting.

Just like any other investment vehicle, bonds are impacted by the economic climate. That might be the national economy or global economy. When interest rates and inflation have to be adjusted to cope with the economy, it has an impact on the demand and profitability of the bonds at that given time.

Corporate bonds are more riskier than government bonds as corporations are liable to go bust should their business fail. This would result in a default on the issue of the bonds. Government bonds have a better credit scoring and therefore historically have been less risky. The returns offered by government bonds tend to be lower than corporate bonds too.

The availability and process of bond investing is very simple. Most financial institutions offer bond investing products. Bond investing is a popular choice for people who are risk averse but want a better return than leaving their capital in bank accounts.

Bond investing is a halfway house between traditional savings accounts and stocks and shares. For this reason a lot of pension pot portfolios tend to be split between minority cash and majority bonds and majority stocks and shares.

Other alternative investment vehicles to bond investing include commodities, real estate and digital currency. These investments tend to be more volatile than bond investing. With any kind of investment a key factor to consider is time frame. Most investments need a minimum 5 year outlook for it to beat an economic downturn.