Most people have heard of bonds in passing at some point, but for a lot of people those mentions come and go in passing, and they never stop to learn what a bond is.
A bond is a loan.
Just like you might need a loan for a car or a house, or even a small loan from a friend (which you should probably avoid getting into), businesses and governments need loans, too. Sometimes that loan is for a construction project, or to put a new product into circulation. Whatever the reason, that institution is going to need a little extra money, and this time, you get to give the loan. They pay you interest, and when the bond “matures,” you cash it in and get your money back. This is different than a stock, where you buy a piece of ownership in a company and watch the value rise or fall. You’re just lending them the money, and looking to get it back with interest.
Why invest in bonds?
A bond is typically a lower-risk investment than a stock. Investors tend to retreat to bonds when the stock market is risky, or invest in them to balance out a high-risk stock. That’s not to say that bonds are foolproof, but they’re much safer than a lot of investments you can make.
What kinds of bonds are there?
Well, there are a wide variety of government bonds, from Treasurys (yes, that’s how that’s spelled) to Savings Bonds. These are backed by the “full faith and credit” of the government, which means it’ll basically never default unless the government collapses or something equally drastic. There are agency bonds, bonds for government-sponsored enterprises, which are a little less safe, but still relatively secure. Municipal bonds fund local government works, and are subject to tax breaks in many places.
Corporate bonds are just what they sound like, and the risk/reward ratio varies wildly depending on the company you’re loaning money to. Companies have a “bond rating” just like you have a credit score. Ratings agencies look at their credit risk and determine how safe it is to loan a company money. Of course, nothing is guaranteed when you’re in the corporate world, but these ratings are a helpful guideline. Just remember, if you buy bonds from a super-shady company, you might not be playing it safer than stocks anymore. At a certain rating, they straight-up start calling them “junk bonds.” Junk bonds offer higher yields than any other kind of debt – if they pay off. But remember – they’re called “junk” for a reason.
How do I make money with this?
The main source of income is the interest. You can also buy bonds at a discount – for instance, you can buy a $1,000 bond for $900, and assuming the price stays stable, you’ll make $100 when you cash it in, plus what you made in interest. Bonds usually pay out a couple of times a year, so you’ve got a relatively stable stream of income. Bond prices and interest rates fluctuate, and you can play that fluctuation and sell the bond before it matures, but that gets a little complicated for an overview.
Are bonds good investments?
Depends on what you’re looking for. They can be extremely low-risk, so if you’re risk-averse, or looking for a relatively safe bet to add some safety to your portfolio, they’re great. Just don’t expect big flashy stock market money.