Both McDermott and Rush from Iboss argue that, despite the lure of high interest rates, keeping all your money in cash is a mistake.
“While interest rates on cash accounts look more attractive than they have for a decade, it is still the case that investing in cash will erode your spending power relative to inflation,” says Rush. “The only way to outperform inflation – and therefore maintain spending power – is to invest in riskier assets.
“Unfortunately, the rather obvious downside of such assets is that they require investors to take risks, a situation that has been relatively uncomfortable since 2022.”
What are the risks of investing in bonds?
When it comes to investing in bonds, the golden rule to remember is the inverse relationship between price and yield. If the yield on a bond goes up, its price goes down, and vice versa.
It’s also vital to appreciate how a bond’s price will move when interest rates change.
“When interest rates rise, bond prices tend to fall, and vice versa,” says Gutteridge. “This is because investors can get a higher return on their money by buying new bonds that pay higher interest rates than by holding on to older bonds that pay lower rates.”
The prices of those older bonds therefore fall, and their yields rise, to compensate. The prices of bonds furthest from maturity are most sensitive to interest rate changes. After all, if a bond is to be repaid in a month’s time, you know you will receive back its face value then, so there is little scope for its price to fluctuate. It’s a different matter if it matures in 10 years.
Another factor to consider is the creditworthiness of the bond issuer. Government-issued bonds are normally perceived to be safer than corporate bonds because there is less risk of default. As a result, government bonds usually offer lower interest rates than their corporate counterparts.
Inflation will erode the value of bonds over time by diminishing the purchasing power of the fixed interest payments, and of the principal when it is eventually repaid.
Why now for bonds?
After the financial crisis of 2008 ushered in an era of ultra-low interest rates, bonds, which by then were yielding close to 0pc, were cast aside as investors rushed into stocks, especially those that offered the prospect of growth.
But now investment experts say bonds are reclaiming their rightful place as a crucial element of a balanced investment portfolio.
“Bonds have been in the doldrums for the past decade, offering investors low levels of income and disappointing total returns,” says Michael Jervis of Sarasin & Partners, an investment manager. “But now they are back and firing on all cylinders as an essential part of a multi-asset investor’s toolkit.”
Jarvis says even the least risky government bonds offer yields about double the 2pc inflation rates that major central banks, including the Bank of England, are targeting.
“Now that inflation appears to be under control, positive real [after-inflation] returns are once again on offer,” he says. “But the biggest benefit is the ability to diversify and be paid real returns for doing so.
“While shares will always be the main engine room of growth in our portfolios, bonds are offering decent returns and the potential to offset the volatility of the stock market, thus smoothing overall portfolio returns.”
Meanwhile, Gaël Fichan of Bank Syz, a Swiss bank, says that for the first time in more than 15 years Britain’s bond market is offering something “unusual”.
“This is a rare moment for anyone thinking about investing,” he says. “While government bonds in the UK are looking good, there’s an even better opportunity with company bonds, especially those from financial companies such as banks.”
He says they are offering returns of about 6pc, a rate not seen in a long time.
“This isn’t just good news for your wallet, it also offers some safety in uncertain economic times,” he says. “Indeed, putting money into these bonds ensures a stable return that might be hard to find in other investments such as stocks, and you can keep this steady return for a long time.”
How to invest in bonds
Investing in bonds can be complicated, but McDermott says it is not something you need to do all by yourself.
“One option is to invest in a ‘strategic bond’ fund,” he says. “These vehicles have all the bond options at their fingertips to adapt effectively to different market conditions: government and corporate bonds, high-yield and investment-grade, emerging markets and developed markets.
“They can be flexible on currency, on credit risk and on inflation protection. We believe the Baillie Gifford Strategic Bond, Invesco Tactical Bond and Nomura…
Read More: What are bonds, how do they work and how do you buy them in the UK?