Bonds: a beginner’s guide

You may have noticed a familiar pattern in recent years.

A government unveils a controversial budget.

A prime minister resigns unexpectedly.

A new spending plan unsettles investors.

Within hours, financial headlines begin repeating the same phrase: “gilt yields are rising”.

But what does that actually mean, and why should you care?

To understand, it helps to start at the beginning.

What is a Bond?

A bond is, at its simplest, a loan.

When a government or company needs to raise money, it can borrow from investors by issuing bonds.

In return, it promises to pay a fixed rate of interest – known as the coupon – at regular intervals and return the original sum (the principal) at a specified date in the future.

Governments issue bonds constantly to fund public services, infrastructure, and to manage national debt.

What are gilts?

In the UK, government bonds are called ‘gilts’ – a nod to the gilded edges of the original paper certificates.

In the US they are called Treasuries; in Germany, Bunds; in Japan, JGBs. Different names, same basic idea.

When you buy a newly issued government bond, you know exactly what you’re getting: say, 4% interest per year for ten years, and your money back at the end. Simple enough.

Why do Bond yields rise and fall?

Here is where it gets interesting.

Once a bond has been issued, it can be bought and sold on financial markets and its price moves with supply and demand, just like shares. This is where the concept of ‘yield’ comes in.

The coupon on a bond is fixed. But if the price of that bond falls in the market, the fixed interest payment represents a higher return relative to what you paid, so the yield rises.

Price and yield always move in opposite directions.

This relationship is central to understanding why politics, economics and financial markets are so closely linked.

How do Bonds relate to politics?

When investors grow nervous about a government’s finances – perhaps because of an unexpected spending announcement, a chaotic budget, or signs of political instability – they become less willing to hold that government’s bonds. They sell. Prices fall. Yields rise.

This is precisely what happened in the UK in September 2022, when the then-Chancellor’s mini-budget spooked markets with unfunded tax cuts.

Gilt yields spiked sharply, sending tremors through pension funds and mortgage markets.

More recently, periods of political uncertainty have triggered similar, if less dramatic, reactions.

What happens when gilt yields rise?

Importantly, rising gilt yields are not just a market story. They have real-world consequences.

Higher government borrowing costs can feed through to higher mortgage rates, more expensive business lending, and increased costs for servicing national debt.

When bond markets move, the broader economy often feels the effects.

Beyond gilts: the wider world of Government Bonds

The UK gilt market, while important, is one part of a much larger global picture.

US Treasuries are considered the bedrock of the global financial system – the ultimate “safe haven” asset.

In times of global crisis, investors typically pile into Treasuries, pushing prices up and yields down. They are the benchmark against which almost every other bond in the world is measured.

German Bunds play a similar role within the eurozone. Their yield is used as the reference point for European sovereign debt, with the borrowing costs of countries like Italy or Spain measured by how much more they pay compared to Germany – a gap known as the “spread.”

Emerging market government bonds – issued by countries in Latin America, Asia, or Africa – tend to offer higher yields to compensate investors for taking on greater political and economic risk.

Across the bond market, the relationship between risk and return remains fundamental: the greater the perceived risk, the higher the yield investors demand.

What are Corporate Bonds?

Governments are not the only borrowers. Large companies – from airlines and pharmaceutical firms to supermarkets and technology giants – also borrow money through bond markets to fund operations and growth.

Corporate bonds function much like government bonds, but they usually offer higher yields because companies generally carry a greater risk of default. Governments can raise taxes or issue more debt; companies do not have the same flexibility.

To attract investors, companies must therefore offer higher yields than comparable government bonds.

The additional return investors receive for taking on this extra risk is known as the “credit spread”. When economic conditions deteriorate or investors become more cautious, these spreads tend to widen.

Bonds vs shares: key differences

Simple, in theory. But how do bonds actually fit into an investment portfolio?

The traditional answer is: as a counterbalance to shares.

Equities offer the prospect of strong long-term growth, but they are volatile – markets can fall sharply and take time to recover.

Bonds, by contrast, provide a steadier income stream and tend to be less volatile. When equity markets fall sharply, investors often move into bonds, pushing their prices up.

The 60/40 portfolio explained

This logic underpins the famous “60/40 portfolio” – a rule of thumb that suggests holding 60% in equities and 40% in bonds.

For decades, this split was the backbone of cautious investing: equities driving growth, bonds providing stability and cushioning losses in downturns.

However, the 60/40 model faced a serious test in 2022, when surging inflation dragged both equities and bonds lower at the same time – a painful reminder that no investment rule survives every environment.

Yet the underlying logic remains sound: spreading risk across different asset classes still makes sense over longer time horizons, and within bonds themselves, active asset allocation – adjusting where you are invested as conditions change – can make a meaningful difference when markets turn turbulent.

How Bond investing changes with age

Where bonds really earn their place, though, is in shaping a portfolio around an investor’s stage of life.

In earlier years, with decades of growth ahead, it makes sense to accept more volatility in pursuit of higher returns from equities.

As retirement draws closer, the calculus shifts: a gradual move towards bonds trades some of that upside for steadier income and greater predictability – a reasonable bargain when you have less time to ride out a market storm.

Why Bonds matter for investors

Bond markets can seem dull, remote and technical – the preserve of traders and economists.

But as recent headlines have shown, they sit at the heart of how governments are held accountable for their finances, and how the cost of borrowing ripples through the economy.

For investors, understanding bonds is not merely academic.

Whether held directly, via funds, or as part of a pension, bonds are almost certainly part of your financial life already.

Knowing what moves them, and why, is a good step to understanding what your money is actually doing.

How a financial adviser can help

An expert financial adviser can help you to decide on what role bonds could play in your portfolio, taking into account your circumstances and your approach to investment risk.

Get in touch with one of our advisers today to find out more.

Disclaimer: This article is for informational purposes only and does not constitute financial, tax, or legal advice. Tax treatment depends on individual circumstances and may change. The value of investments can go down as well as up and you may not get back the full amount you invested. Past performance is also not a reliable indicator of future performance. Always seek professional advice before making financial decisions.