Bond
Definition
A fixed-income debt security where you lend money to a government or corporation in exchange for regular interest payments and the return of principal at maturity.
Bonds are essentially IOUs from governments or companies. When you buy a bond, you're lending money to the issuer for a fixed period. In return, you receive regular interest payments (called the coupon) and get your principal back when the bond matures.
Bonds come in several types: US Treasury bonds (backed by the federal government, considered the safest), corporate bonds (issued by companies, higher yield but more credit risk), municipal bonds (issued by state/local governments, often tax-exempt), and international bonds.
Bond prices move inversely to interest rates — when rates rise, existing bond prices fall, and vice versa. This relationship is fundamental to understanding bond investing. A bond paying 3% becomes less valuable when new bonds pay 5%, so its market price drops.
Bond duration measures sensitivity to interest rate changes. Longer-duration bonds are more sensitive — a 20-year Treasury bond drops much more in a rate hike than a 2-year Treasury. This is why bond funds can lose money despite bonds being "safe" — the individual bonds are safe at maturity, but the fund's market value fluctuates.
For portfolio allocation, bonds provide stability, income, and diversification from stocks. The traditional role of bonds as a counterweight to stocks (rising when stocks fall) has been generally reliable, though both stocks and bonds declined in 2022 when rates rose sharply.
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Frequently Asked Questions
Are bonds safe investments?
US Treasury bonds are considered among the safest investments in the world — the US government has never defaulted. Corporate bonds carry credit risk (the company could default). Bond funds carry interest rate risk (prices fluctuate). Individual bonds held to maturity return their face value regardless of interim price changes.
Why would I buy bonds when stocks have higher returns?
Bonds reduce portfolio volatility, provide predictable income, and can rise when stocks fall. A portfolio with some bonds declines less in a stock market crash, helping you avoid panic selling. The right stock/bond mix depends on your risk tolerance and time horizon.