Bond Funds For Income And Growth ? Helping You Beat Inflation

05.05.10

Please note that this article is over six months old. While Blevins Franks takes care to make sure that information is accurate on the date of publication, some content may change over time. You should not rely on the accuracy of legislation and tax information in this article; take professional advice for your circumstances.

With inflation edging up again and interest rates still at record lows, many savers are now earning lower real returns from their bank deposits than they were a few months ago. Even putting the c

With inflation edging up again and interest rates still at record lows, many savers are now earning lower real returns from their bank deposits than they were a few months ago. Even putting the current environment aside, if you want to ensure that your money lasts for the rest of your life and you can maintain a decent standard of living, you then want to maintain your buying power throughout retirement. In other words, you need to at least match inflation after any income has been taken and taxes paid.

Historically, equities provide the best returns over the longer term and therefore can be a very useful investment to protect your wealth from inflation.

However, your investment choices should be governed by your risk tolerance, time frame and circumstances as well as your objectives, so depending on your situation it may not be advisable to allocate a large portion of your portfolio in equities.

Also, if you require your capital to generate regular income, equities are not the most reliable investment choice as the income fluctuates and you run the risk of having to strip out capital to provide income.

In any case, to reduce risk you should have a diversified portfolio which would include other asset classes besides equities.

A second option to help you keep pace with inflation could be a bond fund. Bonds can be particularly attractive for retired people since they are typically less volatile than equities as an asset class and also provide a higher income. Capital growth is usually lower than with equities, but the income helps compensate for this.

When you buy a bond you are lending a government or corporation money for a stated term and in return receive a fixed amount of regular interest. The rate of interest is usually higher than bank interest rates. It is dependent on the issuer?s credit rating, with high yield bonds offering higher interest than investment grade. At the end of the term investors are paid back 100% of the initial value of the bond at launch, subject to there being no defaults.

Bonds are freely tradable investments and as such have an ongoing price or value before the maturity date, which can be higher or lower than the maturity value. Held within an expertly managed bond fund, the manager will choose the bonds they believe will provide the best income and where appropriate switch between different bond holdings to generate capital growth. The manager will look to identify governments and companies that are more secure than their current market value reflects, to generate further income or capital growth opportunities.

A fund also gives you diversification across a range of bonds, giving you exposure to a number of companies (a fund often has over 100 holdings), sectors, interest rates, maturities, and possibly to more than one currency.

Bond funds give you access to expert investment management and the benefit of a regular income. Alternatively you can accumulate the income within the fund to further increase your capital growth prospects.

The advantages over a bank deposit account are that a bond fund would normally offer a higher rate of interest (helping you outpace inflation) as well as the capital growth element (helping to protect your capital from inflation), something which a bank account does not provide. On the other hand, monies held in a bank account are not exposed to investment risk.

2009 was an exceptional year for corporate bonds, and while we cannot expect a repeat performance, many fund managers anticipate further modest capital appreciation this year, particularly with high yield bonds since the yield differential compared to government bonds is still wide of their long-term average. High yield bonds also still provide superior income generation. A number of strategists say these bonds are their preferred area for investment in bonds, because of the combination of improving company results, less concerns about defaults and investors searching for extra yield.

That is not to say that sovereign worries over countries like Greece could not impact on the bond market, so investors should be prepared to accept fluctuating capital returns in the short to medium term, though this should not affect the income.

You could also consider investing in global sovereign bonds, which are issued by governments and corporations in the emerging market countries. These bonds achieved strong performance over the first quarter of this year and should continue to achieve positive performance, supported by improving global growth indicators and renewed inflows into the asset class. Emerging markets came out of the credit crisis relatively unscathed; are in relatively robust economic health and do not suffer from the structural debt problems we are seeing in the developed world.

These views are put forward for consideration purposes only as the suitability of any investment is dependent on the investment objectives, time horizon and attitude to risk of the investor. The value of investments can fall as well as rise as can the income arising from them. Past performance should not be seen as an indication of future performance. You should seek advice from an authorised financial adviser such as Blevins Franks Financial Management Ltd.

Blevins Franks Financial Management Ltd is authorised and regulated by the UK Financial Services Authority for the conduct of investment and pension business.

By Bill Blevins, Managing Director, Blevins Franks

4th May 2010

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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