Oct
18
2011
Every time you walk into a bank these days you are confronted with an advert for tracker bonds. So, what are these bonds, are they better than a savings account, who are they best suited towards and how do they work?
Tracker bonds have become popular as inflation has risen well above the 2 per cent recommended rate for the Bank of England. These bonds offer an alternative to savings accounts which due to very low interest rates pay tiny returns on money invested.
When you get a bank to invest in a tracker bond, it will be usually be for between 3-6 years and will involve 85 per cent of your money going in a traditional savings account, with the other 15 per cent being invested in riskier investments which have higher yields - this is where the money is made.
As the money is invested for a prolonged period and the investor is not allowed access to it, tracker bonds are ideal for people who are willing to invest over such a period, though still wish to protect their savings.
Tracker bonds pay higher rates of interest than a typical savings accounts – nearly everything does these days to be honest – a typical tracker bond that offers you 100 per cent return on investment will give you between 3-5 per cent returns on investment per year. However, with inflation taken into account this is just around even in real terms.
Tracker bonds often make far more for the financial institution that you invest in than you will see as a return. The bank or investor will invest your bond and the 15 per cent across a range of different areas and make a profit far greater than the 3-5 per cent you get, meaning that there are far better ways for you to invest if you are willing to take the extra risk.
This is only the edge of the downside of tracker bonds. Like any form of investment tracker bonds offer a number negatives. Firstly some of these bonds don’t offer full capital security and so there is a risk you will lose some of the principal. Secondly there may be a cap on the return as we have mentioned – ask about this before investing in the bond as some bonds don’t give you the full maturity you require.
Thirdly you may be paid charges when the bond matures, meaning you lose money on the bond and don’t get as much as you may believe. Look into all of this before investing as well as into other ways of investing that may be straighter forward or may offer a better return.
Bonds are a great way to invest and it is just a case of knowing what to expect from them.
Simon Grant is a writer and blogger who contributes to a vast number of sites including financial blog Fiscal Muses.