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Fixed-rate bonds: What are they and how do they work?

With turbulent markets impacting the value of some investments, some people are looking for other ways to protect their money and save for the future.

Fixed-rate bonds are one way that people are choosing to boost their savings. But what are they?  

Fixed-rate bonds: What are they and how do they work?

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What are fixed-rate bonds? 

A fixed-rate bond is a savings account that you put a lump sum of money into for a fixed period of time at a fixed rate of interest.

Once deposited, you can’t withdraw your money for the term of the investment, and this can be anywhere from one, two, three or even five years.  

Once your bond reaches the end of the investment term, it matures or pays out your returns, leaving you with more than you deposited because of the interest it has earned.

The longer you commit to holding the bond, the better your interest rate will be, which means it can be an attractive way of saving money that you know you won’t need for some time.  

Why are fixed-rate bonds so popular? 

As turbulent markets have impacted the value of some investments, many people are looking for ways to save money at a higher rate of interest than everyday savings accounts.

And for people that don’t want to risk losing any value by investing in higher risk options like equities, fixed-rate bonds are becoming a popular way of securing guaranteed returns over a set period of time.   

How many types of fixed-rate bonds are there? 

There are different kinds of fixed-rate bonds that will offer you different rates of return based on the term that you hold the bonds for.

Different providers will offer different returns and products, so always be sure to understand the specifics of any bond you are considering.

As a general rule, the most common bonds are one, two, three, four and five-year fixed-rate bonds, although you can find bonds with shorter and longer-term lengths.  

Normally, the longer the period of the bond you buy, the better the interest rate and subsequent returns will be.

But, while that may make a five-year fixed-rate bond the most financially attractive bond to buy, remember that this money is locked away for the duration of the bond and cannot be withdrawn.

One-year bonds may not offer the same financial rewards, but the shorter maturity offers you more flexibility and can still help you save for the future.  

In addition to a range of different maturity periods, you can also find tracker bonds, which during periods of rising interest rates, may be the most attractive bonds to hold.

These bonds have a variable interest rate, which increases or decreases as the Bank of England’s base rate changes.  

As with any savings product, it’s important to pay close attention to the terms.

Often, the starting rates of tracker bonds are lower than the base rate. So, if the starting rate on a tracker bond is 3 per cent, while the base rate is 4 per cent, and the base rate increases to 4.25 per cent, the adjusted interest rate on your bond will still only be 3.25 per cent. 

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Advantages and disadvantages of fixed-rate bonds 

The main advantage of buying fixed-rate bonds is that you will have a guaranteed return by the maturity date of your bond, giving you certainty and helping you plan for your future.  

And unlike investing in the stock market or opening higher-risk ISAs, fixed-rate bonds are completely secure should your provider go bust - as long as your provider is covered by the Financial Services Compensation Scheme, which guarantees up to £85,000 per bank per person.

Although the potential returns on a fixed-rate bond aren’t always as attractive as a stocks and shares ISA, this safer investment class offers a good degree of certainty, and can help to balance out higher risk portions of your portfolio.  

But there are some disadvantages too. As mentioned above, buying a one-year bond, for example, could see you with only slightly higher returns than an everyday savings account.  

Moreover, your money is locked away for the period of the bond. If your financial circumstances change during the term and you need to withdraw your money before its maturity date, you might not be able to access it.

Or you may need to pay a penalty. For this reason, despite offering lower returns, many people prefer to buy one-year bonds, rather than the more attractive five-year bonds. 

You should also bear in mind that the income from fixed-rate bonds is taxable.

So, you should consider the impact of any extra income on your tax situation to make sure it’s worthwhile. 

How many fixed-rate bonds can you have? 

You can buy as many fixed-rate bonds as you want, and this can be a good way to retain flexibility to access your savings if you should need to.

You could buy a number of fixed-rate bonds with different term lengths, before using the earlier maturing bonds to buy more.

This way you could have a rolling cycle of maturing bonds to rely on.  

What happens to your bonds after death? 

Banks have different policies about what happens to your bonds after death. In some cases, the next of kin can close the account at the time of their choosing so as to keep the returns generated, but other banks will keep the account open in the deceased’s name until the end of the bond’s term.

Always make sure to check with your bank about its own policy in this matter.  

With markets volatile and inflation high, planning for your financial future can be tricky.

Thankfully, speaking to a financial adviser can help. Find your next financial adviser with Unbiased.  

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About the author
Elizabeth Antaloczy is the Marketing Director at Unbiased and has over two decades of experience writing and producing impactful content that motivates people to take action.