What are Bonds?

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February 1, 2019
What are Bonds?

Image Copyright Ted Grussing Photography – Used with permission

We’ve all heard about Stocks and Bonds and while many people have a good idea of what a Stock is, Bonds seem to be a little harder to define.

  • In short, Bonds are essentially loans which an investor makes to companies, governments, municipalities and other organizations.

It is for this reason that bonds are sometimes referred to as debt instruments, because they are loans from investors.

If you are on the other end and you purchase a bond, you are loaning money to an entity such as a corporation, the US government, Municipalities etc. You will receive a fixed rate of return (the coupon rate) for a certain period of time. The end of which is the maturity date.

For example, say you loan a company, (corporate bond) $10,000 with a 5% coupon rate and a 10 year maturity date.

  • In ten years your 10k invested will have paid you a total of 5k.

The rate of return, or coupon rate, will vary upon the perceived stability of the entity borrowing the money. Government bonds pay less than corporate bonds because the risk of the government going out of business is much less than a company.

Additionally, the value of your bond can fluctuate depending upon new bonds’ coupon rates. That means if new bonds are paying higher rates, your bond is not as valuable to a potential buyer. On the other hand, if newly issued bonds have lesser rates, your bond suddenly becomes more valuable.

Nevertheless, if you hold your bond until its maturity you will get exactly what you were promised. So yes, bonds have less volatility than stocks in general, but historically have not outperformed stocks. This is just one more reason why we recommend having a well-balanced portfolio that includes stocks in ETF’s or Mutual funds.

Have a wonderful weekend!