Fixed Interest: Investment Guide

Find out all you need to know about fixed interest as an investment. 

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Fixed interest is a term used to describe funds in relation to two forms of investment: government gilts and corporate bonds. Fixed interest securities serve as a way for governments or companies to raise money by borrowing from investors. It is a very popular form of investment, providing a regular income.

Gilts are a form of borrowing by the government. They can be taken out for varying terms, paying varying interest rates. Your capital is guaranteed by the government.
 
Corporate bonds are securities issued by businesses and represent a similar form of borrowing to gilts, but involve companies, not governments, and your capital is not guaranteed with this form of fixed interest.
 

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There are various benefits to fixed interest securities, not least the fact they represent a less risky investment than shares, and provide a more stable and regular income from their interest payments. 

Gilts represent an extremely secure option, as you are informed of both the rate of return and when you will receive your capital back. Notably, the UK government has never defaulted on a gilt, although other countries (like Greece and Argentina) have. 

With company bonds, the strength of the business is reviewed to determine a reasonable risk premium compared to a government bond. The company is graded on its security, with a secure company, for example, able to borrow money at one or two percentage points above the gilt rate, and a less financially secure company having to pay perhaps ten percentage points above the government rate. Therefore, the short-term returns can vary in line with the perceived strength of the company.

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Although viewed as a secure investment, fixed interest is more likely than shares, for example, to be affected by any changes in interest rates or inflation.  

With gilts, if you wish to access your money before maturity, you will be required to sell your gilt on the open market. This carries the risk of capital loss. Alternatively, should you keep the gilt until maturity, the valuation each year will be dependent on market conditions.  

Corporate bonds are more complex than government gilts because returns depend on a company's perceived strength. There is more default risk if you opt for corporate bonds or non-UK government bonds. If a company or country goes bust, you can lose some or all of your money.

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Fixed interest is normally classified as a low-risk investment, one that offers a more predictable income for investors than shares, for example. 

However, it is by no means a no-risk investment, as there remains the possibility of short-term capital loss, while returns can be affected by interest rate movement and the security of the companies involved.

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Because of the nature of the investment, fixed interest is ideal for those looking for a certain income stream. It also represents a great way to diversify your portfolio, as it can be added to other forms of investment to adjust the overall level of risk you are prepared to take through your investment strategy.

It is therefore suitable for all but the most cautious investors.

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As mentioned, fixed interest can be affected by changes in interest rates or inflation, so it is important to bear in mind the outlook for these two factors when deciding upon a fixed interest investment. 

The potential for higher interest rates, for example, can weaken the outlook for fixed interest, with a rise in the rates having a larger negative impact on longer dated bonds. High inflation can also reduce the “real” return of a fixed interest bond.

 

This information provided is based upon the opinion of Equilibrium and does not constitute advice. Investments can fall as well as rise.