Bond Investing Guide: Understanding Types, Risks, and Tax Benefits

In simple terms, bonds are a form of loan issued by a business or a government. When you buy a bond (or a piece of the bond), you’re lending your money to this “issuer”. In exchange, the issuer promises to pay the bondholder (that’s you) a fixed interest payment at regular intervals until the loan matures (when you will get back a known amount which is the ‘face value’).

Therefore, you can think of a bond like an IOU – you lend the issuer money, and they pay you ‘interest’ on a regular basis until a pre-agreed date when they pay you a specified sum of money.

What are bonds?

Think of bonds like an investment which pays a regular ‘interest rate’ for as long as you hold it, as well as giving you the chance to make a profit on the money you invest. Unlike stocks, which can fluctuate in value rapidly, bonds will typically offer a relatively ‘predictable’ income stream, making them a good option for more risk-averse investors seeking stability.

The volatility of a bond price depends on who you are loaning the money to. If it’s the UK government, it’s typically a sedate and predictable journey. If it’s a mining company in Latin America, you should prepare for a much more volatile journey.

This is why government bonds typically make up a large proportion of pension funds, particularly for those who are closer to retirement age and thus need their pension to be invested in lower-risk products.

How do bonds work?

Who issues a bond?

When a government or a business decides it needs to raise money, one of the avenues it might take is to issue a bond. The bond specifies the “maturity” date (when the loan is repaid), the “coupon” (interest rate) paid periodically, and the “denomination” (face value) of the bond.

How do bonds pay interest?

The exact monetary value of the coupon you receive from a bond is called the “yield” and typically correlates to how risky the loan is determined to be.

Let’s imagine someone wanted to borrow a grand from you. How much would you want in return for making that loan? It depends how reliable or trustworthy they are. How risky it is, as well as how long they want to borrow it for. In other words, how “creditworthy” they seem to you.

The same principles apply in the world of bonds. If we lend money to the UK government, for example, you might have more faith that they will keep up with their interest payments and repay you in full than if you lent money to a copper producer in the Democratic Republic of Congo. So a UK government bond would typically pay lower interest than the “riskier” copper producer one, for example.

This is why government bonds (often called “gilts” if they're issued by the UK government or "Treasuries" if they're issued by the US government) usually pay less (or have a lower yield) than various corporate bonds – in return for giving you a less hernia-inducing path.

Bond yields move inversely to bond prices. That is, the lower the yield (or ‘interest’ paid) , the higher the price of the bond is. Let’s walk through an actual example to explain how this all works.

How are bonds traded?

Initially, bonds will be offered to institutional investors (like banks or pension funds). When this process is complete, bonds can also be traded on the “secondary market”, where investors trade between themselves on the stock market like you can with ordinary shares. There will be a quoted price that will change throughout the day.

Investors can invest in bonds either directly or via other products which have bonds in them - such as multi-asset funds, ETFs or investment trusts. Bonds can play an important role in creating a diversified investment portfolio, which essentially means you invest in lots of different things in different proportion (not putting all your eggs in one basket is another way of looking at it!).

Many leading investment platforms such as Hargreaves Lansdown, AJ Bell and interactive investor now let retail customers buy bonds just like you would with shares.

What are the different types of bond?

Are bonds right for me?

Good if you

You have a lower risk tolerance

You’re comfortable with lower potential returns in exchange

You want more predictable investments

You’re a higher rate taxpayer wanting tax efficient ‘cash-like’ assets

Bad if you

You’re seeking higher returns

Your priority is maximum capital growth rather than income

What factors affect bond performance?

Historically, bonds have generally offered lower returns than shares but tend to come with less volatility. However, there are various external factors you should be aware of that can influence a bond’s performance, such as:

How do I know how bonds will perform vs cash?

Unfortunately, predicting the future performance of any investment with certainty is virtually impossible.

Bonds have historically been considered lower-risk investments, but this is not a 100% bulletproof rule. For example, in September 2022 - following ex-Chancellor Kwasi Kwarteng’s infamous “mini Budget” - there were serious concerns about the amount of spending the then-government had proposed and therefore how it would be able to keep up with national debt (including gilts).

These questions around the perceived creditworthiness of the UK government impacted the bond market, pushing yields up as these loans were seen to be riskier than they had been beforehand. As yields went up, the price of UK gilts fell - and this caused the bond market to contract, as lending to the UK government became less attractive to investors (institutional and private).

People who were invested in bonds during this period saw the value of their investments fall. For those with a well-diversified portfolio (invested in lots of different things in different proportions), the impact of this was likely to be muted. However, individuals with a high proportion allocated to bonds – such as pension funds, which typically favour bonds for their low-risk reputation – saw a bigger dip.

Since then, the bond market has recovered and it is generally agreed that this was an unusual set of circumstances. Bonds are usually low risk investments and can play an important role in ensuring your investment portfolio is diversified – and not all in shares, for example.

So you can see that by understanding the factors that can influence bond performance, you can get a better sense of how they work and how best to incorporate them into your investment portfolio.

How can I invest in bonds?

If you have a pension or you're an investor already, you likely already invest in bonds - they're extremely common components of pensions and are often included in various types of funds, such as multi-asset funds, ETFs and ready-made portfolios.

Before you hunt for new bonds to add to your portfolio, it's a good idea to check what you're already invested in to make sure you're not doubling up or allocating too much to bonds. If you have a pension product, check your annual pension documents for details on what your pot is invested in. For other investment products, most providers allow you to log into your account on desktop or via an app to see a breakdown of your portfolio.

If you're looking to invest in bonds, there are many investment platforms on the market that will allow you to do so directly. The table below outlines how much it costs to trade bonds on some of the most popular platforms in the UK.

Cost of trading bonds on UK investment platforms

Data correct as at 31/03/2025. There are different caps and restrictions. Please check the details on the provider's site to make an informed decision if you decide to buy.

As with all investing matters, if you’re unsure or feel like you need a helping hand, an independent financial adviser can help you make informed decisions about whether or not to incorporate bonds into your strategy and how to do it. Click the link below to see some experts we've hand-picked.