What a bond is
When you buy a bond, you lend money to the issuer (a government or company) for a fixed period. In return, the issuer pays you regular interest (the coupon) and returns the face value (principal) at maturity. A UK gilt (government bond) paying 4% annually for 10 years with £1,000 face value will pay you £40 per year for 10 years, then return your £1,000. Bond prices move inversely with interest rates: when rates rise, existing bonds paying lower coupons become less attractive, so their market price falls. This is why the 2022 rate-rise cycle caused one of the worst bond market downturns on record.
Historical returns
Over very long periods, global equities have returned approximately 7–8% per year in real (inflation-adjusted) terms. Government bonds have returned approximately 1–2% per year in real terms. The equity premium — the extra return equities provide over bonds — exists because stocks are riskier: they can lose 50%+ in a bear market and companies can fail entirely. The risk premium is the market’s way of compensating investors for bearing that uncertainty. Importantly, shorter periods can look very different — equities have underperformed bonds over multi-year periods (e.g. the 2000s "lost decade" for US equities).
How to think about allocation
The traditional rule of thumb is to hold your age in bonds — a 30-year-old holds 30% bonds, a 60-year-old holds 60% bonds. This has become increasingly questioned: with longer life expectancies and persistently low (now rising) bond yields, many financial planners suggest staying heavier in equities for longer. The key principle remains: the longer your investment horizon, the more equity risk you can afford to take. If you need the money in three years, a 50% equity bear market is catastrophic. If you won’t need it for 25 years, the same bear market is an opportunity.
“Bonds dampen the volatility of a portfolio. Equities provide the return. The ratio between them is your statement of how much uncertainty you can tolerate in pursuit of a better outcome.”
What this means for you
If you are under 40 and investing for retirement, a high equity allocation (80–100%) is generally appropriate — you have decades to recover from downturns. As retirement approaches, gradually adding bonds reduces the risk of a severe bear market devastating your portfolio right before you need it (sequence-of-returns risk). For money you need within 5 years, cash and short-duration bonds are appropriate — not equities. The appropriate allocation is deeply personal and depends on income security, risk tolerance, and specific financial goals. A Target Date fund (which automatically shifts from equities to bonds as your target date approaches) automates this allocation decision.