How to Invest in Bonds from the UK

What Are Bonds and Why Do Investors Hold Them?

A bond is a debt instrument — when you buy a bond, you are lending money to the issuer, which could be the UK government, a foreign government, or a corporation. In return, the issuer promises to pay you regular interest (the coupon) and to return your original loan (the principal) on a specified maturity date. Bonds are generally considered lower risk than equities because bondholders have a legal claim on a company's assets before shareholders in the event of bankruptcy. They also provide predictable income through their fixed coupon payments.

Types of Bonds Available to UK Investors

UK government bonds — called gilts — are backed by the UK government and considered among the safest bonds available. They come in conventional (fixed coupon) and index-linked (inflation-linked coupon) varieties. US Treasury bonds are the safest bonds globally and provide dollar-denominated fixed income. Investment-grade corporate bonds are issued by financially strong companies with low default risk, rated BBB or above by credit rating agencies. High-yield or junk bonds are issued by companies with lower credit ratings and offer higher yields to compensate for greater default risk. They are considerably more volatile than investment-grade bonds.

How Bond Prices and Yields Work

Bond prices move inversely to interest rates — when interest rates rise, existing bond prices fall. This is because a bond paying a fixed 3 per cent coupon becomes less attractive when new bonds are issued at 4 per cent, so its price falls until its effective yield (yield to maturity) matches the new market rate. This inverse relationship means bonds can lose value when central banks raise interest rates — as happened dramatically in 2022 when the Bank of England raised rates from near-zero to over 5 per cent, causing significant losses in bond funds.

Investing in Bonds Through ETFs

Most UK retail investors access bonds through bond ETFs rather than buying individual bonds. Bond ETFs hold a diversified portfolio of bonds and trade on the stock exchange like shares. Key options available in the UK include the iShares Core UK Gilts ETF (IGLT) for broad UK government bond exposure at an OCF of 0.07 per cent, the Vanguard UK Government Bond Index ETF for UK gilt exposure, the iShares Corporate Bond ETF (SLXX) for sterling-denominated investment-grade corporate bonds, and the iShares Global Corp Bond ETF for diversified global corporate bond exposure. All are available within Stocks and Shares ISAs on major UK platforms.

How Much Should You Allocate to Bonds?

The appropriate bond allocation depends primarily on your time horizon and risk tolerance. Young investors with decades until retirement typically need little or no bond exposure — their long time horizon means they can absorb equity volatility and benefit from equities' higher expected long-term returns. Investors approaching or in retirement typically benefit from increasing their bond allocation to reduce portfolio volatility and ensure they have stable income even during equity downturns. The traditional 60/40 equity-bond portfolio — 60 per cent equities and 40 per cent bonds — has been a widely used benchmark for moderate-risk investors.

Bonds in the ISA

Bond ETFs can be held within a Stocks and Shares ISA, sheltering all coupon income and any capital gains from UK tax. This is particularly valuable for bond investors who rely on regular income, as coupon income outside an ISA would be subject to Income Tax. When selecting bond funds for an ISA, look for those with low OCFs, broad diversification across many bond issuers, and a credit quality appropriate for your risk tolerance.