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Bond (noun) bonds

According to the English dictionary this word has many definitions. It can also have numerous meanings in a financial context and in my experience is the most common cause of confusion between adviser and client whenever it is discussed.

This problem arises because it can refer to many different types of investment products or contracts; each with varying degrees of risk/reward characteristics.

Bonds can roughly fall into the following three categories:

  • Fixed Term Bonds
  • Government and Corporate Bonds
  • Investment Bonds

Fixed Term Bonds

These are basically sold and marketed through banks and building societies and probably the easiest to understand. The investor deposits a sum of money for a set term and the bank promises to pay an advertised rate of interest.

Things to look out for in the fine print are the use of introductory bonus rates that are removed after an initial period, loss of interest if withdrawals take place, use of gross advertised rates which will be reduced by at least two fifths (savings tax) for most tax payers, with a liability for even more tax for higher and additional rate taxpayers. Of course this tax can be avoided if the bond is placed inside an ISA wrapper, but even so it is not unheard of for financial institutions to offer better term deposit rates which are not always available within their own cash ISA’s. In addition, capital rest periods – the periods (usually daily, monthly, or annually) before interest is calculated and added, can effect total returns if money is deposited before of or remains after the advertised start and end dates of the fixed term.

The biggest dilemma for clients is how long to ‘lock’ their money away for. The most common terms are 1, 2, 3 and 5 years. It will come as no surprise that in most instances the longer the term the better the annual rates are. Rates are usually fixed although variable rate term deposits are available.

These accounts can be operated in branch or by phone, internet or post. Some institutions will offer all options but most will limit these means of communication to one or two. This may seem a trivial matter but several years down the line it is not always a quick and seamless transaction to liquidate money even when instant access is permitted. Decisions. Decisions. Decisions.

Next time I will cover corporate bonds in the second of a three part instalment and if, in the meantime, you would like guidance or advice on any of the subjects discussed do not hesitate to get in touch.

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