{"id":2556,"date":"2024-12-17T09:29:38","date_gmt":"2024-12-17T17:29:38","guid":{"rendered":"https:\/\/qa.simplifimoney.com\/blog\/what-are-bonds\/"},"modified":"2024-12-17T09:29:38","modified_gmt":"2024-12-17T17:29:38","slug":"what-are-bonds","status":"publish","type":"post","link":"https:\/\/www.quicken.com\/blog\/what-are-bonds\/","title":{"rendered":"What Are Bonds: How They Work &amp; How to Invest"},"content":{"rendered":"\n<p>Bonds can be an income-generating cornerstone of many modern portfolios. They\u2019re often less risky than stocks, but still riskier than a savings account. They offer diversification and income potential to fine-tune your risk-reward balance.&nbsp;<\/p>\n\n\n\n<p>But before investing, it\u2019s important to know: what, exactly, are bonds?&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">What you need to know<\/h2>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Bonds are loans that investors make to governments or companies<\/li>\n\n\n\n<li>Bonds come with specific maturity dates (time to repayment) and interest rates<\/li>\n\n\n\n<li>Higher-quality bonds have less risk and lower rates; \u201cjunk\u201d bonds pay higher rates for more risk<\/li>\n\n\n\n<li>Investors can mix and match bonds to balance risk, income, and diversification<\/li>\n\n\n\n<li>Before buying any bond, it\u2019s important to check its credit rating and yield&nbsp;<\/li>\n<\/ul>\n\n\n\n<div class=\"blue-box\">\n    <p>See how Quicken helps you track your investments.<br>\n    <a href=\"https:\/\/www.quicken.com\/goals\/grow-diversify-investments\/\" class=\"cta-link\">Get started \u2192<\/a><\/p>\n<\/div>\n\n\n\n<h2 class=\"wp-block-heading\">What are bonds?<\/h2>\n\n\n\n<p>Bonds are fixed-income assets, meaning most offer regular income. Technically, they\u2019re loans between the investor (lender) and the issuing company or government (borrower). The borrower usually pays interest until it\u2019s time to pay the loan in full.&nbsp;<\/p>\n\n\n\n<p>Investors may buy bonds to create income or diversify away from stocks. However, not all bonds are created equal. Some are more likely to default (not repay their debts) than others.&nbsp;&nbsp;<\/p>\n\n\n\n<p>That\u2019s the simple definition. Now, let\u2019s unpack the specifics.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">How bonds work<\/h2>\n\n\n\n<p>Governments and businesses issue bonds to raise money for goals or projects. Each bond is evaluated for its creditworthiness, which is the likelihood the issuer can repay the loan. In turn, this factors into a bond\u2019s interest rate and risk level.&nbsp;&nbsp;<\/p>\n\n\n\n<p>Investors who buy bonds lend money to these issuing entities. In exchange, the investor receives periodic interest payments until the bond matures.&nbsp;<\/p>\n\n\n\n<p>These interest payments usually happen semiannually, but may also come annually or quarterly. Bonds may set fixed or variable interest rates, which can change the income potential.&nbsp;<\/p>\n\n\n\n<p>After a set period of time, the bond matures or comes due. At this point, the issuer repays the principal, and the loan closes.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Essential bond jargon<\/h3>\n\n\n\n<p>The bond world uses a lot of terms. We\u2019ll touch on some key phrases here.&nbsp;<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Issue price: <\/strong>The price the issuer sells the bond for (often a \u201cpar value\u201d of $1,000)<\/li>\n\n\n\n<li><strong>Bond price:<\/strong> The price to buy the bond from other investors second-hand, which may differ from the par value<\/li>\n\n\n\n<li><strong>Par value, face value, or principal:<\/strong> The price the investor receives at maturity, regardless of the issue or bond price<\/li>\n\n\n\n<li><strong>Coupon rate:<\/strong> The interest rate the issuer pays the investor, based on the face value<\/li>\n\n\n\n<li><strong>Maturity date:<\/strong> The date the issuer must repay the bondholder\u2019s principal<\/li>\n\n\n\n<li><strong>Bond yields:<\/strong> A way to measure interest that considers the bond\u2019s fluctuating value<\/li>\n\n\n\n<li><strong>Secondary market:<\/strong> Where investors trade bonds after buying them from the issuer<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\">Why invest in bonds: pros and cons<\/h2>\n\n\n\n<p>Like all assets, bonds carry a unique set of pros and cons to keep an eye on.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Benefits of investing in bonds<\/h3>\n\n\n\n<p>Bonds offer investors several unique benefits, including the ability to:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Generate relatively stable income via regular interest payments<\/li>\n\n\n\n<li>Earn higher rates than most savings accounts pay<\/li>\n\n\n\n<li>Diversify away from stocks and cash, possibly lowering your portfolio\u2019s volatility<\/li>\n\n\n\n<li>Potentially sell bonds for more than you pay for them (capital appreciation)<\/li>\n\n\n\n<li>Protect against economic slowdowns and even inflation<\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\">Risks associated with bonds<\/h3>\n\n\n\n<p>While bonds are generally safer than stocks, that doesn\u2019t mean they\u2019re risk-free! Bond investors should watch out for:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Credit risk: <\/strong>The risk a bond\u2019s credit rating will fall, resulting in lower prices on the secondary market<\/li>\n\n\n\n<li><strong>Default risk:<\/strong> The risk the issuer won\u2019t make interest or principal payments<\/li>\n\n\n\n<li><strong>Interest rate risk:<\/strong> The risk that bond values will fall when rates rise<strong>&nbsp;<\/strong><\/li>\n\n\n\n<li><strong>Liquidity risk:<\/strong> The risk you won\u2019t be able to sell your bonds early if you need to<\/li>\n\n\n\n<li><strong>Inflation risk: <\/strong>The risk you\u2019ll lose purchasing power, since most bonds don\u2019t adjust for inflation<\/li>\n\n\n\n<li><strong>Call risk: <\/strong>The risk a bond issuer will repay the bond early\n<ul class=\"wp-block-list\">\n<li>Not all bonds are \u201ccallable\u201d; the issuer should alert you to this fact upfront<\/li>\n<\/ul>\n<\/li>\n<\/ul>\n\n\n\n<div class=\"blue-box\">\n    <p>Track all your investments in Quicken, even across accounts.<br>\n    <a href=\"https:\/\/www.quicken.com\/goals\/grow-diversify-investments\/\" class=\"cta-link\">Get started \u2192<\/a><\/p>\n<\/div>\n\n\n\n<h2 class=\"wp-block-heading\">Types of bonds<\/h2>\n\n\n\n<p>Every type of bond carries its own risks, rewards, and tax implications. Knowing the difference can help you make more informed investment decisions.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">U.S. Treasuries<\/h3>\n\n\n\n<p>Treasuries (or \u201cTreasurys\u201d) are bonds issued by the U.S. government. They\u2019re considered some of the safest investments in the world, as the U.S. has never defaulted. Investors can purchase these bonds directly from the U.S. Treasury.<\/p>\n\n\n\n<p>Treasuries come in several varieties:&nbsp;<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Treasury bills<\/strong> mature in 52 weeks or less. Instead of paying interest, they\u2019re sold for less than their face value and pay their face value at maturity.&nbsp;<\/li>\n\n\n\n<li><strong>Treasury notes<\/strong> mature in 2, 3, 5, 7, or 10 years. Notes pay semiannual interest.&nbsp;<\/li>\n\n\n\n<li><strong>Government bonds<\/strong> mature in 20 or 30 years. Bonds pay semiannual interest.&nbsp;<\/li>\n<\/ul>\n\n\n\n<p>Treasury Inflation-Protected Securities (TIPS) offer a unique trade-off: their value links to inflation. When inflation rises, the principal rises, and vice versa. Many investors use TIPS to counteract periods of high inflation.&nbsp;&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Municipal bonds<\/h3>\n\n\n\n<p>States, cities, and other local governments can issue municipal bonds, or \u201cmunis.\u201d These bonds raise money for public needs and typically mature in under ten years.&nbsp;<\/p>\n\n\n\n<p>Investors may buy munis for their tax benefits, as most munis aren\u2019t subject to federal income taxes. (They may also be exempt from local taxes, depending on your location.) However, because of these advantages, munis may pay lower yields than corporate bonds.&nbsp;&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Corporate bonds<\/h3>\n\n\n\n<p>Some corporations issue bonds instead of getting a bank loan to fund growth or new projects. Investors can buy these directly from the company or on the secondary market.&nbsp;<\/p>\n\n\n\n<p>Corporate bonds come in two basic flavors:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Investment-grade bonds<\/strong> are less likely to default, and so pay lower interest rates<\/li>\n\n\n\n<li><strong>High-yield or \u201cjunk\u201d bonds<\/strong> come with higher default risk but pay higher rates&nbsp;<\/li>\n<\/ul>\n\n\n\n<p>Regardless of their credit rating, corporate bond income is taxable at federal and state levels.&nbsp;&nbsp;&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">International and emerging market bonds<\/h3>\n\n\n\n<p>Investors can also buy bonds from foreign companies and governments. Before going international, though, it\u2019s important to understand potential risk factors.&nbsp;<\/p>\n\n\n\n<p>In general, developed markets have stronger economies and governments. As such, bonds from these markets tend to boast higher credit ratings. Still, investors should watch out for economic, political, and social risks.&nbsp;<\/p>\n\n\n\n<p>Bonds from \u201cemerging markets\u201d tend to have lower credit ratings due to factors like:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Political instability<\/li>\n\n\n\n<li>Poor corporate governance<\/li>\n\n\n\n<li>Currency fluctuations<\/li>\n\n\n\n<li>And\/or unstable governments&nbsp;<\/li>\n<\/ul>\n\n\n\n<p>Like high-yield U.S. bonds, many pay higher rates to reflect their elevated risk.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Key concepts for bond investments<\/h2>\n\n\n\n<p>We\u2019ve already touched on some essential bond jargon. Now, let\u2019s explore the key bond concepts every investor should know.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Bond ratings and credit risk<\/h3>\n\n\n\n<p>Bonds are evaluated by credit rating agencies like Moody\u2019s or Standard &amp; Poor\u2019s. A bond\u2019s rating represents its riskiness based on the issuer\u2019s creditworthiness. (However, ratings don\u2019t guarantee returns.)<\/p>\n\n\n\n<p>Investment-grade bonds receive credit ratings of Baa3 (Moody\u2019s) or BBB- (S&amp;P) or higher. Since they\u2019re less likely to default, they generally pay lower rates.&nbsp;<\/p>\n\n\n\n<p>High-yield or \u201cjunk\u201d bonds have lower ratings because they\u2019re more likely to default. They offset some of this risk by paying higher interest rates. Often, lower-rated bonds are issued by younger, foreign, or financially troubled companies.&nbsp;<\/p>\n\n\n\n<p>Importantly, a bond\u2019s rating isn\u2019t fixed. Credit agencies can upgrade or downgrade ratings if circumstances change.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Interest rates and bond prices<\/h3>\n\n\n\n<p>Bond prices and interest rates move in opposite directions. When rates fall, prices rise, and vice-versa.&nbsp;<\/p>\n\n\n\n<p>The reason is simple: When interest rates fall, existing bonds suddenly pay a higher rate than new bonds. That can cause existing bond prices to rise as investors seek these higher returns.&nbsp;<\/p>\n\n\n\n<p>Conversely, higher rates mean that existing bonds aren\u2019t paying as much as new issues. Investors can take this opportunity to buy bonds at a discount compared to their face value.&nbsp;&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Duration and yield-to-maturity (YTM)<\/h3>\n\n\n\n<p>Investors should also keep an eye on a bond\u2019s duration and yield-to-maturity.&nbsp;<\/p>\n\n\n\n<p>Duration here does NOT refer to the time until a bond\u2019s maturity. Rather, duration describes how much a bond\u2019s price will move when interest rates change by 1%. Investors can use duration to compare bonds across face values, coupons, and maturities.&nbsp;&nbsp;<\/p>\n\n\n\n<p>Yield-to-maturity refers to the total anticipated return if you buy a new bond and hold it until maturity. (Usually expressed as an annual interest rate.) Investors can use YTM to compare bonds of different coupons and maturities.&nbsp;&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">How to evaluate bond investments<\/h2>\n\n\n\n<p>Before buying bonds, it\u2019s important to do your due diligence. Be sure to evaluate each bond (and how it fits into your portfolio) with care.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Analyzing market conditions<\/h3>\n\n\n\n<p>Current market conditions can change your bond-buying math. Consider factors like:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Current interest rates. <\/strong>Are they high or low? What kind of rates do investment-grade bonds pay? High-yield bonds? How do they compare to each other?<\/li>\n\n\n\n<li><strong>Recent or anticipated interest rate changes.<\/strong> Has the Federal Reserve recently moved interest rates? In which direction? Does this present a chance to get better rates or prices on the secondary market?&nbsp;<\/li>\n\n\n\n<li><strong>Bond prices.<\/strong> What prices do bonds go for on the secondary market right now? How does that compare to new issues? Could this change soon based on interest rate announcements?<\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\">Considerations for financial goals<\/h3>\n\n\n\n<p>After evaluating the market, it\u2019s time to match your picks to your financial goals.&nbsp;<\/p>\n\n\n\n<p>Older investors and those closer to their goals may prefer more bonds than stocks. Bonds tend to be less volatile, which means less risk of loss. That makes them ideal for generating income or slowly growing money you\u2019ve already made.&nbsp;<\/p>\n\n\n\n<p>Younger investors and those further from their goals may prefer fewer bonds. A stock-heavy portfolio has a chance to build wealth faster, but at a greater risk of loss.&nbsp;<\/p>\n\n\n\n<p>However, every investor is different. You\u2019ll want to consider your timelines, specific goals, <em>and <\/em>your risk tolerance. For instance, if you\u2019re risk-averse, you may prefer more bonds than someone your age \u201cshould\u201d have. Peace of mind can be worth a lot!<\/p>\n\n\n\n<p>You may also prefer bonds for specific goals where you\u2019re unwilling to risk ANY stock market losses. (E.g., your house-buying fund or car fund.)&nbsp;&nbsp;<\/p>\n\n\n\n<p>There\u2019s no right or wrong way to choose your bonds. There\u2019s only right and wrong for YOU.&nbsp;&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">The role of bonds in a diversified portfolio<\/h2>\n\n\n\n<p>Bonds can look \u201cboring,\u201d but they\u2019re an essential component in many portfolios. They offer diversification and steady income potential. Investors can even use them to buy low and sell high. (That is, buying at a discount and receiving face value at maturity.) Plus, they can bring peace of mind during economic turbulence or high inflation.&nbsp;<\/p>\n\n\n\n<p>But which bonds you buy \u2014 and when \u2014 matter enormously to your goals and financial outcomes. And once you\u2019re invested, it\u2019s important to keep an eye on them to ensure your decisions continue to serve your needs.&nbsp;<\/p>\n\n\n\n<div class=\"blue-box\">\n    <p>Track your complete portfolio in Quicken, even across accounts.<br>\n    <a href=\"https:\/\/www.quicken.com\/goals\/grow-diversify-investments\/\" class=\"cta-link\">Get started \u2192<\/a><\/p>\n<\/div>\n\n","protected":false},"excerpt":{"rendered":"<p>A bond is a type of debt issued by a corporation, government or other organization where the purchaser pays a certain amount to purchase the bond and, in exchange, will receive either a lump sum after a certain period of time or specified recurring payments over a period of time. For example, you might pay $50 to buy a bond that will pay you $75 in 10 years or will pay you $10 per year for the next seven years.<\/p>\n","protected":false},"author":52,"featured_media":8274,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_seopress_robots_primary_cat":"106","_seopress_titles_title":"What Are Bonds: How They Work & How to Invest | Quicken","_seopress_titles_desc":"Bonds give investors a chance to lend (not borrow) money for a change. In return, they offer diversification, income, and portfolio stability potential.","_seopress_robots_index":"","inline_featured_image":false,"footnotes":""},"categories":[106],"tags":[],"class_list":["post-2556","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-investing-retirement"],"acf":[],"jetpack_featured_media_url":"https:\/\/www.quicken.com\/blog\/wp-content\/uploads\/2024\/12\/reading-mail-during-breakfast.png","_links":{"self":[{"href":"https:\/\/www.quicken.com\/blog\/wp-json\/wp\/v2\/posts\/2556","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.quicken.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.quicken.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.quicken.com\/blog\/wp-json\/wp\/v2\/users\/52"}],"replies":[{"embeddable":true,"href":"https:\/\/www.quicken.com\/blog\/wp-json\/wp\/v2\/comments?post=2556"}],"version-history":[{"count":3,"href":"https:\/\/www.quicken.com\/blog\/wp-json\/wp\/v2\/posts\/2556\/revisions"}],"predecessor-version":[{"id":8295,"href":"https:\/\/www.quicken.com\/blog\/wp-json\/wp\/v2\/posts\/2556\/revisions\/8295"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.quicken.com\/blog\/wp-json\/wp\/v2\/media\/8274"}],"wp:attachment":[{"href":"https:\/\/www.quicken.com\/blog\/wp-json\/wp\/v2\/media?parent=2556"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.quicken.com\/blog\/wp-json\/wp\/v2\/categories?post=2556"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.quicken.com\/blog\/wp-json\/wp\/v2\/tags?post=2556"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}