Twice the rate of a building society (Corporate Bonds)

Member Name: opinions4u

Product:	Corporate Bonds
Date:	23/04/03 (1857 review reads)
Rating:

Advantages: Higher income than a savings account

Disadvantages: An element of risk, No capital growth

Well, if you can make more than 4% interest on your savings in the current climate you are doing a fine job of managing your money.

For the context of the review, with a bank or building society investment, you are effectively lending your money to the bank to lend to someone else to buy a house. It should be as safe as houses.

But what are those weird and wonderful bond things that you see in the financial press, advertising returns of 6%, 7% or even 8%!

They are Corporate Bonds! Still none the wiser? Well, in short, a Corporate Bond is a loan to a business. Simple as that. You lend a company your money, they invest it in their business (expansion, restructuring, takeover - it's their call), and then repay you with interest. In likelihood, your investment will probably be pooled in a unit trust or investment company and lent to a number of different companies.

Sounds good? Well, in certain circumstances it is. But just because something quotes a high rate, does not mean you should start throwing your money at it.

Is your investment safe? The answer is safeish. If the company you invest in goes broke, you will lose your money. But if there are remaining assets when a company ceases trading, you get your money back before the shareholders. The company can also default on payment, which creates expense in recovering money owed. In other words, Corporate Bonds are a safer bet than stocks and shares, but a little riskier than an investment in a bank account.

Will they make you rich? The simple answer is no. The idea is that this sort of investment will pay you interest, and at the end of the term you get your capital back. The interest paid is higher than that from a bank or building society account. So, £100,000 in the Halifax at 3.5% will pay less than £300 a month, whereas a 6% corporate bond fund will pay £500 a month. You can see how beneficial this would be to a pensioner trying to maximis

e their income in the latter years of life. But the value of your initial investment will only grow if you buy in to a corporate bond fund when things are going wrong, and it subsequently recovers. And it could fall.

Is it taxable? Well, the income generated is subject to income tax, although you
can invest £7,000 per tax year per person (£14,000 for a couple) in an ISA and escape the tax! You can also offset any capital losses against Capital Gains Tax (unless you're capital is invested in an ISA), although you would not expect to make significant losses in the sort of investment.

How much does it cost? Well, this varies from plan to plan. There could be initial charges (anything from nothing up to 5%), annual management charges (anything from nothing up to 1.5%) and exit fees if you wish to withdraw capital (anything from nothing up to 5%). Additionally, a plan manager paying a high income (eg 8%) may deduct these fees from the capital, whereas one paying a lower income (eg 5%) may already have deducted the charges, so a 5% advertised return could actually be as good as an 8% advertised return!

With pooled investments, the advertised return cannot be guaranteed. This is because each time a new arrangement is made by your fund manager with a company, the rate agreed will be based on that point in time. In other words, a 6% return now could become 6.1% next month and 5.9% the month after. The bigger the fund, the less volatile these changes should be. But the advantage of pooled investment is spreading the risk across a range of businesses. Many funds prefer to pay income quarterly, which should be fine, but make sure it fits with your individual needs.

So, why do different Corporate Bonds pay different rates? Well, as well as the different ways of charging investors, there is also the risk profile of the companies lent to.

M&G quote 5% for their Gilt & Fixed Interest Fund. Seems a bit average,
but because of the exposure to Gilts (a loan to the government, as opposed to a loan to a business) th
e investment is safer.

Halifax quote 6% for their Corporate Bond fund. They only lend to companies with AAA ratings (companies considered to be financially stronger than the Halifax themselves), so it is a relatively safe investment, but not as safe as M&G.

That nice killer from Eastenders who advertises Abbey National, offers us in excess of 7%. A decent return, although achieved with a loans to higher risk companies than the Halifax equivalent.

In other words, the higher the return, the higher the risk. The old lesson for savers. If it looks too good, it probably is!

Should you have a Corporate Bond? Well, see an independent financial adviser before making any investment decision. Speaking generally, if you need an income with only modest capital risk (usually the older among us) this could be the way forward. Make sure you maximise your ISA allowances each year on it as well. Over 5 years a couple can end up with £70,000 invested tax free, which is not to be sniffed at!

If you are saving for the long term and looking to grow a fund for a specific reason, such as pension or school fees, this is probably not the right option.

www.halifax.co.uk
www.abbeynational.co.uk
www.mandg.co.uk

There are a large range of providers and the three mentioned here are not necessarily the best. Please feel free to use this article to help form an understanding of Corporate Bonds, but do not make an investment decision because of it. See that IFA!

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