Bonds are more or less fancy loans. Governments and companies may issue bonds to help them fund their business, whether they need the money to put towards a specific project or simply their day-to-day operational costs. In purchasing a bond as an investment, you are temporarily giving your money to the company to use for a fixed period of time. In the same way that you would be required to pay interest on a loan, credit card, or line of credit from a bank, the company or organization that borrows money from you must also pay interest on that money. When the fixed amount of time is over, you are repaid the original sum of the loan in addition to interest.

Considering Risk and Returns

Bonds are considered a lower-risk investment than stocks. As a result, since the 1950s stocks have consistently provided more substantial returns than bonds. However, there have been a few exceptions. Returns on bonds were high between 2000 and 2002 and during the Great Recession in 2008. In 2011, bonds once again offered higher returns than stocks. It’s important to remember, though, that just because bonds are considered low-risk doesn’t mean a return is guaranteed. Bonds are referred to as “fixed-income” investments because both interest payments and the span of the bond are fixed. Returns, however, are not guaranteed.

Characteristics of Bonds

While there are plenty of different types of bonds, most share several defining characteristics. Face value, also known as par value, refers to the bond’s principle, or amount to be returned to the lender at the end of the bond’s term. Most bonds in the United States have a principle of $1,000 USD. The interest rate is paid by the bond issuer and represents a fixed percentage of the bond’s face value or principle. Interest rates are higher for companies that are more volatile and therefore more likely to default on loan payments. Interest rates are lower for well-established, stable companies. The yield is the total amount of interest paid annually on the bond. Finally, the maturity date is the fixed end-date of the bond. At the date of maturity, the bond issuer returns the principle to the investor. Bonds may last anywhere between a couple of months to more than ten years.

Investing in Bonds

Unlike stocks, bonds are a great way to access a stress-free source of income. While bonds do have risks, they also have other benefits, one of which is diversification of an investment portfolio.

When you combine stocks and bonds, you can balance risk and returns for a stable combination. In addition, income is steady over the term of the bond, as opposed to most other investment options, which pay when you sell or at the end of a given term. For this reason, bonds are a good option for retirees. Bonds are also far more secure than many investments. After savings accounts, they are one of the most liquid ways to keep your money. One final benefit of bonds is that some are not taxed.