Investing in Corporate or Government Bond Funds

A bond is a debt instrument. When you buy ‘a bond’ your money is being loaned to a company or government that needs to borrow.

This loan will be repaid on a preset date for a known price. In between your purchase and that repayment date, interest is paid on the loan. These loans and the organisations borrowing are categorised according to the risk (you) the investor takes in lending. The best are called Investment Grade whilst the rest are Junk. Guess which you should go for?

Junk bonds (also known as High Yield) pay higher returns, but there is extra risk of default attached to those higher payments. Often you will find that Investment grade bonds pay between one and two percent per year more than money in the bank.

As you can see, this is low risk stuff. To make it easier for the novice and also a little less risky in making a bad decision, look for a fund (unit trust, OEIC or mutual fund) into which you can invest. The fund will have holdings in dozens of these loans and is managed by professionals. If one loan goes into default, you will barely notice the difference in the fund, but if you invest all your savings into one bond issue – and that one folds – you will be nursing quite a loss.

As well as picking a dud, it is also possible to make a capital loss on a bond. This is because the capital value fluctuates relative to issues like currency strength, inflation and interest rates and the stock market. To save getting this wrong, it will be easier and safer to choose a fund. Get some advice from your adviser (or me) as to a suitable pick.