How to buy Bonds and do I need them?

[lifshitzrodda]

Hi - new to investing and recently set up a SIPP with Interactive Investor. I plan to retire in about 12-13 years.

On a pension pot of c.£100k in SIPP at the moment I went 90% equity, investing in a popular index tracker for the long term (set and forget!). From my research I also understand that it's good to have a portion of the portfolio invested in bonds. This is where I got lost! It was easy for me to get my head around funds and long-term investing in them, but with selecting bonds product i am slightly confused.

Does it even make sense to hold bonds now if the intention is to leave the investment (so the c.£10k) for 10 years? Would it not be better to put it all in the equity tracker fund for this length of time? That would be 100% of my portfolio in equity.

And say I did want some income in 5 years (or when I get to the age which allows me to withdraw from the SIPP), then what do I invest in shorter term? Individual bonds? Bonds fund?

I don't find the search for bonds products as easy as with other equities S&S and funds I researched and the funds structure is unclear to me. Also what the link with inflation? My basic understanding is that in principle you loan money to a government or a corporate and get it back +interest, so the yield figure tells you what would this be in %.. but Im sure it's more complicated than this.

Can anyone help me understand the bonds market a bit better? Im on the ii platform so can also do with some products recommendations. Thanks!

anyone??

No one like bonds? ☹️

Have you read ii's bond pages https://www.ii.co.uk/bonds Probably a good place to start if you haven't.

At the risk of the whole egg-sucking thing, in simple terms a bond is essentially a piece of paper with a given face value (let's say for argument's sake £100) and what's called a 'coupon'. The coupon is the amount that it pays out in a given period. Let's say the coupon is £4 per annum, paid quarterly. So each bond will pay £1 every quarter, and overall this gives a 'yield' of 4%. The bond will also have a fixed time frame at the end of which the issuer will pay you back the face value and stop paying the coupon. If you want your capital back before then you'd normally have to sell the bond to someone else at whatever price they are willing to pay, or there are heavy surrender penalties (as anyone who has ever broken a fixed term deposit at a bank will know - these are basically bonds).

But, investors might not think a 4% return is appropriate. If the issuing company (or government) is perceived to be risky, the investor might only offer £90 for the £100 bond. If the issuer sells it at that price then the yield would actually be 4.44% even though the coupon is still £4. Or, an investor might place such a high value on a steady income that they pay £110 for the bond, giving a yield of 3.6363%.

Some bonds, usually government issued ones, will adjust the coupon for inflation, but as I understand it most do not, and of course you'd pay much more for such a bond.

For anyone looking for a fixed income they are useful, but the reason to hold bonds in an broader investment portfolio is that they tend not to be as volatile as share prices and if a corporate bond issuer goes bust, bond holders are generally above shareholders in the pecking order for receiving any assets left. So they are less risky, but the flip side is a lower rate of return compared to equities.

There are various bond funds out there, and there are bond ETFs as well, which will offer diversification. Also, corporate income fonds may will be a mix of dividend-paying equities and bonds. I'm not with ii so don't know what their research tools are like, but there should be some suitable funds in their Super 60 list.

Why not just invest in a mixed fund that invests in equities and bonds, in certain proportions, saves you having to work out what bonds to buy. You could invest in something like Vanguard Lifestyle 80, which invests 80% in equities and 20% in bonds. Other investments are available, that’s just one of many.

There are some strategic bond funds which are much less volatile than equities, with a yield pick up over cash. Some of them (VT-AI) will even sell the underlying bond investments and go into the money markets ie 'off risk' when the manager thinks the market is about to go down.

Retirees or those approaching retirement typically prefer bonds or bond funds over equities for two main reasons:

1. Income Stability: Bonds provide regular, predictable interest payments, which help retirees meet ongoing living expenses.
2. Lower Risk: Bonds are generally less volatile than stocks, making them safer for preserving capital during retirement when there's less time to recover from market downturns.

Many managed funds gradually move to a higher ratio of capital into bond funds as the investor nears their retirement date due to the sequence of returns risk.
A string of poor returns early in retirement can deplete savings faster than anticipated, even if the average return over the whole retirement period is positive. It locks in losses and accelerates the depletion of the portfolio, sometimes making it unsustainable for income.

There are many strategies that can be adopted-
Bonds; bond funds; using a bond ladder or using a managed fund;
Switching to higher dividend-paying stocks with some growth potential;
Keeping a percentage of the portfolio in money market funds or cash-like equivalents sufficient ride out a dip in the equity market for a year or two; Also using a Cash ISA to tide over a dip until markets recover.

The sequence of returns risk is most pertinent to those in or nearing retirement. Earlier on during the accumulation phase the tendency is to focus on the growth potential of the portfolio and counteracting the effects of inflation.