The basic idea
When you buy a bond you lend money to the issuer, a government, a city or a company. In return the issuer promises regular interest payments and to repay the original amount on a set date.
The vocabulary
- Face value (par): the amount repaid at the end, often 1,000 dollars per bond.
- [Coupon](/glossary/coupon): the yearly interest as a percentage of face value. A 4% coupon on 1,000 dollars pays 40 dollars a year.
- [Maturity](/glossary/maturity): the date the bond ends and your principal returns.
- [Yield](/glossary/yield): the return based on today’s price, which can differ from the coupon.
- [Credit rating](/glossary/credit-rating): an agency’s opinion of how likely the issuer is to repay.
Who issues bonds
- US government: Treasuries, considered to have very low default risk.
- Municipalities: “munis,” whose interest is often exempt from federal tax.
- Corporations: higher yields than Treasuries, with more risk. Lower-rated ones are called junk bonds.
The risks
- Interest-rate risk: when rates rise, existing bond prices fall. See bond prices and interest rates.
- Credit risk: the issuer may miss payments or default.
- Inflation risk: fixed payments buy less if prices rise.
- Call risk: some bonds can be repaid early, usually when rates have fallen.
Holding to maturity vs selling early
If you hold a bond to maturity and the issuer pays, you receive the promised interest and your principal, whatever the price did in between. If you sell early, you get the market price, which may be above or below what you paid.
Owning bonds through funds
Many investors buy bonds through bond ETFs or mutual funds for instant diversification. A fund has no maturity date, so its price keeps moving with rates.
Quick answers
Are bonds safer than stocks?
Generally less volatile, yes, but safety varies with the issuer and maturity. A long-term corporate bond fund can drop meaningfully when rates rise.