Many of you may already have an inkling about shares – how they give you a share in the ownership of a company and maybe, sometimes, also a share of its profits1.
But what exactly is a ‘bond’?
In my experience, bonds are less well understood. So here’s a quick guide.
Because together with shares, bonds are among the most common and accessible forms of investment. They can also play a very important role in an investor’s portfolio.
What are bonds?
Bonds are a type of loan to a government or company. Investors lend the money to the issuer of the bond and, in return, the government or company typically agrees to pay a certain amount of interest for a fixed period and to repay the original sum at the end of the term2.
New government bonds are usually first sold (or ‘issued’) via auction but bonds, generally, can also be sold through investment banks. The buyers are often other financial institutions including insurance companies, pensions funds and fund managers but can sometimes be individual investors too.
Similarities between bonds and shares
What do bonds have in common with shares?
Once issued by a government or company, bonds are then traded in a market much like shares. They can change hands frequently. This means that their value is always rising and falling as they are constantly bought and sold at different prices3.
By comparison, property, another common form of investment, is much ‘lumpier’ since ownership changes more slowly – usually over weeks, if not months.
There is also a rich variety of both shares and bonds to choose from. In all, the global bond market is valued at about £95 trillion4, which is bigger than the global shares market.
Like shares, bonds can be grouped together to form funds – funds that individuals like you and me can easily invest in via an investment platform such as Vanguard’s, with each fund representing maybe hundreds, if not thousands, of different entities.
Bonds have a long track record too, so there is a considerable amount of bond performance data that you can collate, compare and contrast with other well establised forms of investment – like shares.
Differences between bonds and shares
But that’s where the similarities between shares and bonds end.
I’ve already highlighted the main difference: the fact that shares represent a slice of ownership paying an uncertain income and bonds are a type of interest-paying debt that must be paid back in full by the borrower after an agreed period. But there are other differences too, which can make all the difference to your long-term, investment success.
Historically, bond and share prices have tended to move in different directions – not always, but usually – and by different magnitudes too.
While shares have tended to deliver better returns in the long-term than bonds, the historical tradeoff has been greater volatility – or a higher risk of a loss. Bonds, on the other hand, have by and large been more stable than shares.
Your mix of bonds and shares
While past performance provides no guarantee of future performance, these historical differences in behaviour help to explain why investors should think about the mix of shares and bonds they hold.
Because, once you’ve figured out what you want to achieve by investing – your goal, including the time you have to get there – and once you know how much price volatility you are prepared to tolerate along the way, you need to think about the investments you will need to help get you to that goal.
This is what Vanguard’s second investment principle – balance – is all about.
For more on our investment principles, watch this video.
For more on the Vanguard funds you can invest in to create your own balanced portfolio, including ready-made portfolios that combine bonds and shares for you, view our product range. If you’re still unsure about the best way to create your own balanced portfolio, you’ll also find a tool there to help you choose your funds. Just click on ‘Get started’.
Alternatively, talk to a financial adviser or allow our experts to do it for you through our Managed ISA.
1Shares can also pay income. This can contribute significantly to a share investor’s total return and usually comes out of a company’s profits. But these dividend payments can vary. Some listed companies don’t pay dividends at all.
2 It is why bonds are often also referred to as ‘fixed-income’ investments.
3For the purposes of this discussion, we are dealing principally with shares and bonds that are listed on a stock exchange.
4There were $118 trillion fixed-income securities outstanding across the globe in the third quarter of 2022, according to the Securities Industry and Financial Markets Association’s (SIFMA) last research quarterly report published on 28 April 2023 . £1=$1.24 as at 31 May 2023.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
The eligibility to invest in an ISA depends on individual circumstances and all tax rules may change in future.
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