What Is a Bond?

Bonds can appear very complicated as there are a lot of terms that you would not hear outside of the finance space that are used to talk about bonds. You may hear words like “Dividends”, “Gilts”, “Limited Time Securities”, “Ex-Dates”, and many other overly-complicated sounding terms.

You may be surprised to learn that the concept of bonds are actually very simple and can be shown with an easy equation.

Bonds = Selling Debt.

That’s it. If you see “Government Bonds” it means the government is selling debt. “Corporate debt” means a company is selling debt, “Green bonds” mean an entity is selling debt to build sustainable projects, the list goes on and on.

So Why Do They Matter?

Bonds are the primary method by which modern governments take out debt to help cover spending deficits or to invest in new projects. This debt does not magically get created from thin air but rather is purchased by individuals like you or me. Of course, you would not give out your money and not expect something in return so that is where interest rates come in. The interest on a bond is the amount that you will be paid back in excess of what you originally paid over the course of the year.

If you spend £100 to buy a bond and that bond has a 5% interest rate, you will receive the equivalent of 5% back per year over the lifetime of the bond (Compounded + your original investment).

Government bonds are known to be the safest as a Government can print more money should they need to cover financial shortfalls in order to match their bond repayments.

As they are very safe, they usually have very low returns.

Typically, the riskier a bond is, the higher the interest rate yield it will provide but you must be careful as the company or entity could declare bankruptcy at which point your bond is completely worthless and you have lost everything! This is why diversification is key to protecting and building long-term wealth because if one company fails, it won’t wipe out your entire bond holding!

Bonds get more complicated when you factor in inflation, economic policies, politics, portfolio management etc however the core concept is still the same. One entity is “buying the debt” of another entity, essentially, giving out a loan to another entity.

You yourself can buy a government bond today and, if you do, the government owes YOU money. That’s a pretty cool way to show the government who’s boss!