How bonds work

It’s no secret that loans power most big purchases such as cars, equipment, and houses. And that’s precisely what a bond really is – a loan to a business.

When a government or a reputable company wants to invest more than they can afford, they typically sell bonds to raise capital for a simple reason. The kind of money they can borrow from investors, using this method, is usually way above what banks are willing to offer. And that explains why it remains the go-to option for qualified businesses.

Bonds come with heaps of benefits for angels (informal investors) as well as the receiving company. For example, the investor receives a percentage of their seed money annually or semiannually. So you can think of bonds as a solid passive income stream that can be liquidated at any time.

The borrower, on the other hand, gets to save a ton of money in interest rates – something that’s not possible when working with challenger banks. Plus, they also get to choose a favourable repayment term.

However, the initial buying price, also known as face value, fluctuates with time. That’s why the yield (or interest rate) is inversely related to the current price. When the valuation goes up, the interest rate drops a notch and vice-versa.

Getting started

The number one rule for investing in a new bond is assessing your current exposure. The last thing you want in a portfolio is too many high-risk investments. So you might want to compare the bond mixture and determine if you’ll be adding to the risk or diluting it.

Another element to look out for is the financial health of the borrower. Are they in a position to pay up or are they likely to burst in a couple of years? Look out for companies with AAA ratings or similar. That way, you can be assured of getting a good return on your investment.

Once everything falls into place, buy the bond from a reputable broker, exchange or directly from the government for as little as £1,000.

Alternatives to bonds

Diversifying your investments is pivotal to your success. An alternative to conventional investing is crowdfunding. Start-ups use platforms such as CrowdCube to get funding, and that’s an excellent place to go hunting.

Investing in property is also a safe bet. But it typically comes with a huge price tag. So you may need to find a bunch of interested investors or take the buy-to-let route to pull it off.

The key thing is to ensure you’re on top with your research and get advice from a qualified adviser when necessary.

Written by Samantha Frost

Copyright Io4 UK Limited

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