Investing your student loan: Corporate bonds
The student loan is often eaten up by necessary expenditure as soon as it arrives. However, many people dont need to use all of the student loan immediately, and if this applies to you and this is particularly the case if you have been able to find part time work to fit around your study you should consider using any surplus to make you some extra cash. Interest rates from standard savings accounts are low at the moment, thanks to the record low bank of England base rate; and so for significant growth, you may wish to look at low risk investment products like corporate bonds.
Corporate bonds are issued by companies looking to raise finance, and in return for what is effectively a loan, the investor receives regular fixed interest payments for the term of the bond, which is usually a few years this is why corporate bonds are also known as fixed interest securities. In practice, private investors usually invest in corporate bonds through brokers like Legal & General.
As you are no doubt aware, the difference between savings and investment products is risk. Savings products advertise an interest rate, and provided that you adhere to the terms and conditions, you will receive the predicted growth and this is protected by law.
Investments on the other hand carry the risk that the funds that you initially put in can diminish as well as grow. This can be due to poor performance, of even the complete failure of the company. The first casualty of poor performance is share price; indexes like the FTSE track these movements in value, which are based on the trading of the shares. The trading itself is a reflection of how investors view the fortunes of the company; for example, sudden accidents like an oil spill can significantly impact on the share price of seemingly solid companies like BP.
Investment in corporate bonds by the private investor is different to investments in company shares for two main reasons. Firstly, when trouble occurs, corporate bonds investors are the first in line to receive payment from available funds, and this means the payment of the promised fixed interest, or yield, from the corporate bond is dealt with first shareholders dividends are a lower priority. However, the risk still remains that very poor performance by the company will result in a reduced yield from the bond, and also perhaps a reduction in the initial capital invested this can occur because corporate bonds are traded on the money markets, and so can in themselves be subject to a reduction in value.
However, the second way that corporate bond investment differs from becoming a shareholder in one company is also the reason that the potential risk of losing money is lower than that associated with direct investment in shares. Private investment is usually into a corporate bond fund, and this fund is commonly comprised of the bonds issued by many different companies. This means that the risk of investment is spread over the combined performance of many companies, and not the fortunes of just one, and in this way overall risk of poor performance is lower it is very unlikely that all of the companies in the fund will perform badly at the same time. Although similar combined funds exist for investment in shares, corporate bond or fixed interest securities are a lower risk investment product, thanks in part to the rules described above.
The first method of investment in corporate bonds should always be through your annual stocks and shares ISA allowance, because the interest gained through money invested in this way is tax-free. Gains from non-ISA investments count as income, and are therefore taxable. Since the annual personal limit for stocks and shares ISA investment is currently £10,200 this financial year, you are unlikely as a student to come close to exhausting this limit.
