You may have to bond a little to get a fairer share

Bonds are an alternative to equity shares if you want to earn an income on your investment

Falling yields on shares have set a tough question for those seeking income from investments. If yields on equity income funds are scraping 3 per cent, where do you find decent returns? For many, the answer has been bonds.

Falling yields on shares have set a tough question for those seeking income from investments. If yields on equity income funds are scraping 3 per cent, where do you find decent returns? For many, the answer has been bonds.

Bonds come in several shapes and forms. At their most basic, there is the guaranteed income bond, where you hand your money over for a term between one and five years and get a fixed income.

You need to make sure you won't need the money in that time. But continuing economic growth suggests interest rates may rise again. Do you want to fix if rates then go higher?

Justin Modray, investment adviser at Chase de Vere, says: "Returns are around 6 per cent, although you can get better from a bank or building society. New bond issues are still worth watching for because companies sometimes increase rates to attract new money." Guaranteed income bonds make more sense for higher-rate taxpayers because they pay net of basic tax. "If you have slipped into the lower tax bracket when the bond expires, you may avoid paying extra tax."

National Savings also issues a variable rate income bond. This pays a safe but less than thrilling 5.45 per cent gross on investments under £25,000, rising to 5.7 per cent over £25,000. Single premium insurance company bonds offer slightly higher levels. This type comes in two forms, unit-linked bonds and with-profits ones.

Unit-linked bonds are riskier because they invest your money in the stock market where it is subject to the highs and lows of equity investments.

With-profits bonds lock in annual gains with a yearly bonus that cannot be withdrawn, even if the market falls. There is a further bonus when the bond expires. Rates are between 5 and 6 per cent and falling."If inflation is 6 per cent and you earn 10 per cent, you get the same return as if inflation were 2 per cent and your return 6 per cent," says Mr Modray.

Philippa Gee, an independent financial adviser in Shrewsbury, likes corporate bonds, IOUs issued by companies to raise money to expand their business. The risk is that the company will default on the bond. Corporate bond funds reduce the risk by investing in a range of them. High-yield funds take greater chances with your cash by investing in bonds with a greater chance of default.

These higher returns are tempting many. The most recent bond fund, Schroder Monthly High Income, pays an estimated gross annual income of 8.75 per cent. "A standard corporate bond will pay between 6 and 6.5 per cent income, but higher yield funds pay between 9 and 10 per cent," says Ms Gee. "The income is attractive but the danger is your capital will be depleted."She says high-yield bonds are fine if you know the risks and spread your portfolio. "Make sure it does not represent your only type of investment. You need to strike a balance."

Mark Dampier, head of research at Hargreaves Lansdown, says a newer bond paying a high guaranteed income is attracting investors who are not always aware of the dangers - the income may be guaranteed, but your capital is not. "You will get all your capital back at the end of the term only if the stock market index the fund is linked to does not fall below a certain level," he says.

Canada Life International's High Income Bond pays 10.5 per cent gross for three years and is linked to the volatile Nasdaq index. Provided that does not fall by more than 20 per cent over the term, you get your full capital back. If it falls your money will be eroded.

"Canada Life is able to guarantee your income because if the Nasdaq falls the money will come from your capital, which doesn't seem that great a deal to me."

Independent Partners; request a free guide on NISAs from Hargreaves Lansdown

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