Stocks get all the attention. Bond markets are roughly twice the size of stock markets globally — and they move the world in ways most people never see. Central bank decisions, government budgets, mortgage rates, corporate borrowing costs — bonds are underneath all of it. Understanding them isn't optional for any serious investor.
A bond is a loan. When a government or company needs to raise money, one option is to borrow from investors directly. They issue bonds — essentially IOUs that promise to pay back the principal (the amount borrowed) at a set date in the future, plus regular interest payments (called coupons) along the way.
Over 10 years you collect £400 in coupons, then get your £1,000 back. Total return: £1,400 on a £1,000 investment — before inflation.
This is the most important — and most counterintuitive — concept in bond markets. When interest rates rise, existing bond prices fall. When rates fall, bond prices rise. Here's why.
Imagine you buy a bond paying 3% annually when that's the market rate. Now rates rise to 5%. Your bond still pays 3% — it can't change. But no new investor would pay full price for a 3% bond when they can buy a new one at 5%. So your bond's price falls until its effective yield (coupon divided by market price) equals 5%. The yield and the price always move in opposite directions.
The coupon is fixed. The price adjusts until the yield matches the market. Fall in price, rise in yield — always.
Bonds and stocks tend to move in opposite directions during market stress. When equities crash, investors typically flee to government bonds, pushing bond prices up. This negative correlation makes bonds a genuine diversifier — not just a different asset, but one that tends to rise when the rest of your portfolio is falling.
This relationship held reliably for decades. In 2022 it broke down — both stocks and bonds fell hard simultaneously as inflation spiked and central banks hiked rates aggressively. That was unusual; the long-run correlation is still negative. But it's a reminder that no diversification is guaranteed forever.
Bonds vs stocks — not either/or: most serious long-term investors hold both. Stocks provide growth; bonds provide income and reduce volatility. The classic 60/40 portfolio (60% stocks, 40% bonds) has been the starting point for professional portfolio construction for decades. How you weight them depends on your age, goals, and risk tolerance.
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