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Fixed Rate Bonds

Following on from my research into bank accounts and other financial products I came across a term that I have never heard before and I was interested to learn more about it. You always hear people talking about bonds but what exactly are they and how do you make money from fixed and variable rate bonds? Let's find out;

So what exactly is a fixed rate bond? Well a fixed rate bond is similar to an ISA or normal savings account which allows ordinary people like you and I to earn interest on our money by investing it for a certain period of time. A fixed rate bond allows people to invest anything upwards of £500 (some accounts can only be opened with a minimum of £10k deposit) and earn a fixed rate of interest for a predetermined amount of time.

The problem with any type of savings account is you are not supposed to touch your money once you invest it until the end of the contract. This means if you invest £10k and for whatever reason need to withdraw £5k of that, you might not be able to, or at the very least will take some time to withdraw.

A fixed rate bond as far as I can tell is like lending money to the bank in return for a fixed interest rate that is paid out at a predetermined length of time. In turn, the bank will invest the money you 'lent' them in order to make more money from it than they pay you in interest. If they make a loss on your money they still have to pay you the fixed interest rate they quoted you before you setup the bond. So what is the difference between a fixed rate and a variable rate bond and why should you choose one over the other. As we have already worked out, a fixed rate bond's interest payments do not change, therefore it can be seen as the safer investment. This is very true however as with any investment, this is not 100% safe. Inflation is the biggest downfall of fixed term bonds and at the current rate of inflation in the UK (at time of writing near 4.5%), a 4 year bond might actually lose you money as the worth of the initial investment has gone down 4.5% each year while only making say 3% per year extra.

Fixed rate bonds usually pay out once every 12 months but some never pay out until the end of the term of the bond. For example, you can take out a fixed rate bond over 4 years which will pay you 4% interest per year. Some bonds will pay 4% of your investment into another account at the end of the year, others will pay the 4% but put it on top of your initial investment (so you earn interest on your interest) while other bonds will not pay out anything until the end of the 4 years. The more you invest and the longer you leave it in there for without touching it represents a higher interest rate. If you only invest £1000 over 12 months for instance you will only have a return of say 1.5%. If on the other hand you invested £1,000 over 5 years you may get a return closer to 4.5% per year.

The main benefit of purchasing a fixed rate bond is you know from the very start how much money you are going to make. It is not one of those investments where you have to keep an eye on the stock market every day as no matter where the market moves, you will always be paid the fixed rate you agreed to when you took out the bond. If you have some money set aside that you could happily do without for a couple of years I suggest looking into Fixed Rate Bonds as a safe way to make money without having to know a lot about the financial world. Check out Natwest, Halifax and Scottish Widows for good examples of fixed rate bonds.

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