Bonds
A loan to a government or company that pays periodic interest and returns principal at maturity.
What is it?
A bond is a debt security: the issuer borrows money from bondholders and agrees to pay periodic interest (the coupon) plus return the principal at maturity.
How does it work?
Bonds trade on markets, and their price moves inversely to prevailing interest rates. Bondholders can hold to maturity or sell earlier at the market price.
Why do people use it?
Used for income, capital preservation relative to stocks, and diversification within a portfolio.
Potential advantages
- Generally lower volatility than stocks
- Predictable income stream via coupon payments
- Wide range of issuers and credit qualities to choose from
Potential disadvantages
- Price can decline if interest rates rise
- Issuer could default (credit risk), especially for lower-rated bonds
- Returns are generally lower than stocks over long periods, historically
Risks
- Interest-rate risk
- Credit/default risk
- Inflation risk (fixed payments buy less over time)
- Liquidity risk for some bonds
Quick facts
- Liquidity
- Varies — government bonds are generally highly liquid; some corporate or municipal bonds trade less frequently.
- Fees
- Trading costs/spreads vary by broker and bond; bond funds charge an expense ratio.
- Taxes
- Interest is generally taxed as ordinary income, with exceptions (e.g., some municipal bond interest may be exempt from federal and/or state tax under current law).
- Guarantees
- None on price; the issuer's promise to pay interest and principal depends on its creditworthiness, not a government guarantee (except for direct government-issued bonds, which carry the issuing government's backing).
- Non-guaranteed elements
- Market price before maturity, and the issuer's ability to pay as promised.
- Time horizon
- Ranges from short-term (months) to long-term (30+ years), depending on the specific bond.
- Who typically considers it
- Investors seeking income, lower volatility relative to stocks, or portfolio diversification.
- Who regulates it
- The SEC regulates bond markets and disclosure; FINRA oversees broker-dealers that sell bonds.
Questions to ask a professional
- What is this bond's credit rating?
- How does its price react if interest rates rise?
- Am I holding to maturity or might I need to sell early?
This is educational information, not a recommendation to buy, hold, or avoid this product. Whether it fits your situation depends on your goals, other holdings, and circumstances a licensed professional can help you evaluate.