Gilts and bonds

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4. Bonds compared to shares

Bonds and shares are very different beasts. As a shareholder, you own a piece of the company, and your rewards rise and fall in line with its profits. As a bondholder, you are a creditor of the company. You receive your interest and capital payments, but the amounts don't go up and down with company profits.

This 'debt' as opposed to 'equity' characteristic of gilts can be a good and a bad thing. If the economy is doing well, and companies are growing profits, being stuck in fixed-interest may not be the place to be. You may miss out on big capital gains in the equity markets.

On the other hand, when the economy is slow, and companies are reporting lower profits, both dividends and share prices tend to fall, and gilts can be a safe haven, particularly if income is a priority for you.

Let's compare some of the features of bonds and shares:

1. Predictability
   • The income you receive from a bond is known from the start, and is usually fixed, so you can plan your finances around it.
   • Dividends from shares are not so predictable, because they rise and fall according to how well a company is doing.
2. Downside
   • If you invest in government bonds (gilts) or the best quality corporate bonds, you can be confident that the interest payments and capital repayment will actually be paid. The risk of default is low. If you invest in lower quality bonds, the risks can be high.
   • Shares can lose a large proportion of their value very quickly and, ultimately, can be worth nothing.
3. Upside
   • If you hold bonds to maturity, you will be repaid their par value, which may be more than you paid for them. So, it is possible to make capital gains (and losses), although most private investors do not trade in bonds in this way.
   • Shares offer better opportunities for capital growth. Prices tend to move faster and further than bond prices.
4. Liquidity
   • Gilts are very liquid. You should never have a problem buying or selling them. Corporate bonds may be less liquid.
   • Shares can be liquid or illiquid. As a rule, large FTSE companies present no problems, but smaller companies can be very difficult to trade, especially selling in bear markets.

So, which are better - shares or bonds? That depends on a lot of things: your financial position, your age, your goals, your tolerance for risk, and, frankly, on the economic position at the time you're investing.

We'll explore all these points on the following pages. First - a quick note on tradeability.

1. What are bonds? 2. Different types of issuer 3. Different types of bond 4. Bonds compared to shares 5. Bonds as tradeable instruments 6. Nominal yield 7. Calculation of current yield 8. Capital gains on gilts and bonds 9. Calculating the redemption yield 10. Factors which affect bond prices 11. Are bonds for you? 12. Selecting gilts and bonds 13. How to buy gilts and bonds 14. Unit trusts and bond funds 15. Keeping track of your bond investments 16. Tax 17. Conclusion

• First Steps in Bonds
• Beating the Dow with Bonds
• Pricing Convertible Bonds