Personal Finance: There's No Common Bond in Bonds - They Vary a Lot; Bonds Are Gaining in Popularity among Investors as Global Stock Markets Remain in Doldrums. but How Many Really Understand These Often Complicated Products? Peter Axon Starts a Two-Part Analysis of the Bond Market
Byline: Peter Axon
Bond is a much used word in the world of investment. Indeed, the multitude of products that carry the name can give the impression that each operates in much the same way.
However, there is no common bond. These investment plans work in different ways and the levels of risk involved can vary considerably.
The popularity of bonds has risen dramatically over the past few years. Probably the main reason why people have gravitated towards these investment vehicles has been the collapse in share prices.
Small investors reeling from the global stockmarket meltdown are anxious to find safe havens.
Bonds are viewed by many as the ideal survival strategy during these turbulent times and private investors are taking a lead from the punch-drunk life assurance sector which has taken such a battering from equity values.
Furthermore, independent consultants are eager to see clients snap up bonds in order that the financial services industry can keep its head above water.
Even so, there are other potent reasons why small savers are hoping to safeguard their future by seeking the relative sanctuary offered from several types of bond. Although sheltering from the worst effects of the stockmarket downturn has been the priority, the acute investor has also had an eye on the future.
Next financial year the tax advantges of holding shares within an ISA wrapper will all but disappear.
Removal of the 10 per cent dividend tax credit will also apply to collective/pooled funds such as unit trusts. This perk will also vanish for assets in a PEP.
However, bonds escaped Chancellor Brown's attention and retain their 20 per cent tax drawback from the Treasury under the ISA tag. City experts predict a long road to recovery on stock exchanges around the world, so a careful assessment of the relative merits stemming from a host of bond products appears a prudent move.
Even within the comparative safety-net of the bonds market there lurks a variety of bond which has already caused countless misery for thousands of small investors who have lost much of their savings.
This, of course is the so-called high income stockmarket-linked bond.
This presents a clear warning to cautious investors that not all bonds are immune from share price volatility and capital erosion.
In other words, seductive market packaging can disguise the precise mechanisms behind this product to the detriment of the bondholder.
Yet how many of us really make a concerted effort to look beyond the gloss to see how profits are generated ?
Lack of time and jargon mean that the mass of small print containing the terms and conditions of purchase are hardly digested. Therefore we can easily come to grief with the discovery of some nasty clauses - often too late.
For example, the imposition of market value adjusters (also known as market value reductions) on with-profits bonds over the past year exemplifies this.
Nonetheless bonds still ride in the investment popularity stakes and the Association of British Insurers estimates that UK investors placed more than pounds 6 billion into investment bonds in 2001.
The reason is that they have long been regarded by savers as perfect investment tools which provide sound returns. Many consider them to be a compromise between deposits (capital security, but miserly rates of interest) and the stockmarket (considerable potential but matching risk).
In many cases, investors not only have a selection of markets, but also the choice of fund manager they wish to handle their precious savings. There is the added attraction that bond issues can release a steady stream of income to supplement a pension, or allow profits/bonuses to remain in the fund to accrue growth.
But although figures can look appetising, savers should remember that to procure impressive returns the general rule is that the higher the income the higher the risk. …