Bonds: A Beginner's Guide to A Classic Investment

A bond is a way for an investor to loan money to a company or government. When you buy a bond, the company uses your money to invest in the company and pays you an interest rate. Most bonds pay interest annually or semiannually. When the bond matures the face value of the bond is paid to you as a return of principal. 

Depending on the length until the maturity date of the bond, an investment in bonds may be a short, medium, or long-term investment. Bonds can be for any length of time and may command a higher return with longer maturities.

A bond is a simple-to-understand investment that gets a little more complicated when you buy and sell bonds instead of holding them. The price of a bond is influenced by interest rates, meaning a bond’s par value can change from the time you buy it to the time you sell it. If the interest rate goes up the value of the bond tends to decrease. If the interest rates go down, then the price of your bond would tend to increase.

Types of Bonds

Some bonds have a greater potential yield than others. One bond may have less chance of being defaulted on than another bond. The first thing to understand about what makes bonds different from one another is who issued the bonds and what type they are.

  • US Treasury Securities- “Backed by the full faith and credit” of the United States, the United States Treasury would have to be in a state of major economic catastrophe for these bonds to be defaulted on. Prices rise and fall on the market, but there is very little chance the investment will lose significant value while you hold it.
  • US Savings Bonds- Also issued by the federal government. These are simple and straightforward. They can be purchased in small amounts, making it an accessible option for people who do not have a lot of money to invest.
  • Municipal Bonds- These are issued by non-federal government bodies such as states, cities, and counties. Many municipal bonds support specific projects, such as purchasing new fire department equipment or repairing roads.
  • Corporate Bonds- Are issued by all kinds of companies. Corporate bonds are segmented by the types of industry, according to the company that offers them. Being backed by a company instead of a government body means that there is a larger chance the bond could be defaulted on if the company goes under.
  • Bonds in International and Emerging Markets- These are bonds issued by governments or companies that are not in the United States. Although international and emerging markets can be used to diversify a portfolio, they carry a separate set of considerations than other types of domestic investments.

This is not an exhaustive list. There are many more kinds of bonds you can invest in, including some that are complicated to understand. Just like any other kind of investment, you must perform the due diligence required to make sure you’re investing in bonds that are right for you and your investment strategy.

A diverse portfolio holds many types of investments, and bonds tend to play a role of stability and income. That diversification continues to be important even as beginner investors gain experience and experiment with more aggressive investments. The conservative nature of bonds make them an investment worth considering for young and experienced investors alike.