The basic mechanics of a bond
Suppose the UK government issues a £1,000 bond paying 4% per year for 10 years. You buy this bond. Each year, you receive £40 (4% of £1,000). After 10 years, you receive your £1,000 back. Total income: £400 in coupons plus your principal returned. The 4% coupon is fixed in cash terms — it does not change with market conditions, inflation, or anything else. This predictability is why bonds appeal to retirees and income-focused investors: you know exactly what you will receive and when. Government bonds (called gilts in the UK, Treasuries in the US) carry essentially no default risk — the government can always raise taxes or (for those with their own currency) print money to pay. Corporate bonds pay higher coupons to compensate for the risk the company might default.
How bond prices and yields move together
Bond prices and yields move inversely — this is the most important concept in fixed income. If you buy a bond paying 4% and market interest rates then rise to 6%, new bonds pay 6%. Your 4% bond is now less attractive, so its price falls until its effective yield (coupon relative to price) equals 6%. Conversely, if rates fall to 2%, your 4% bond becomes very valuable — its price rises. This means: rising interest rates hurt existing bond values, and falling rates boost them. This is why bond fund investors suffered significant losses in 2022 when central banks raised rates sharply — the bonds they held fell in price to reflect the new, higher rate environment.
“A bond is simply a promise. The question every bond investor must ask is: how reliable is this promise, and am I being paid enough yield to compensate for the chance it is broken?”
What this means for you
UK government gilts and investment-grade corporate bond funds are the most accessible ways to invest in bonds, available through ISAs and SIPPs. Short-duration bond funds (1–3 year) are less sensitive to interest rate changes and suit investors who want stable income without much price volatility. Long-duration funds (10–30 year) offer higher yields but significant interest rate risk. Bonds serve two roles in a portfolio: income generation and diversification from equities (government bonds tend to rise during equity crashes as investors seek safety). For most long-term investors, a low-cost global bond index fund covering both government and investment-grade corporate bonds provides efficient fixed income exposure without requiring individual bond selection.