When most people think about investing, stocks are the first thing to come to mind. However, bonds are also part of many of our clients’ overall financial strategies – though many people are not familiar with how bonds can contribute to their overall financial health. In this post, we’ll break down what bonds are and the various types available in the market. 

What Are Bonds? 

Bonds are debt securities given by governments and corporations to raise capital. When you invest in a bond, you basically lend money to the issuer in exchange for interest payments. The interest payments are typically made on a semi-annual basis. At the end of the bond’s term, the issuer will return your initial investment, also known as the principal.

How Is Bond Pricing Typically Determined?

The price of a bond is decided by several factors, including:

• The interest rate
• The length of time until maturity
• The creditworthiness of the issuer

The interest rate is the most important factor in determining the price of a bond. If interest rates go up, the cost of bonds will typically decrease, and vice versa. This is because individuals can get better returns when interest rates go up by investing in other assets, such as stocks.

Bond maturity is also a factor, as bonds with longer terms typically have higher prices. And finally, the issuer’s creditworthiness is important because it affects the likelihood of getting your interest payments and your principal back.

How Do You Make Money with Bonds? 

There are two ways to make money with bonds. Interest payments are the most common. When you buy a bond, you are entitled to interest payments from the issuer at regular intervals. The size of the payments will depend on the coupon rate of the bond, which is the interest rate that is set at the time of issuance.

Capital gains are another option. If you hold a bond until it matures, you will get your principal back. If interest rates have lowered since you purchased the bond, then your bond will be worth more than what you paid. You can then sell it for a gain.

Always remember that bonds are debt security, which means there is a risk that the issuer will not be able to make the interest payments or return your principal. This is why it’s important to research the issuer’s creditworthiness before investing.

How Long Do You Hold a Bond? 

The length of time you hold a bond is known as maturity. Bonds can have maturities of anywhere from a few months to 30 years. The longer the maturity, the greater the bond price.

What Are Some of the Risks of Bonds? 

As with any investment, there are potential risks involved with investing in bonds. The most common risk is interest rate risk, which is the possibility that interest rates will go up and your bond will lose value. 

There’s also credit risk, which is the possibility that the issuer will not be able to make interest payments or return your principal. And finally, there’s inflation risk, which is the possibility that inflation will decrease the value of your interest payments.

Having a firm understanding of these risks is important before you decide to invest in bonds.

Basic Bond Types 

Now that we’ve gone over the risks linked to bonds, let’s look at the different types of bonds available in the market:

Government Bonds

These are issued by national governments and are considered very safe investments. The most common type of government bond is the treasury bond, issued by the U.S. government. Treasury bonds have maturities of anywhere from 2 to 30 years.

Corporate Bonds

Companies issue corporate bonds to raise cash for their businesses. These are considered somewhat riskier than government bonds, but they typically offer higher interest rates. Corporate bonds have maturities of anywhere from 1 to 30 years.

Municipal Bonds

State and local governments typically issue these bonds to finance projects such as infrastructure development. They are considered very safe investments, as they are backed by the full faith and credit of the issuing government. Municipal bonds typically have maturities of 10 to 30 years.

Emerging Market Bonds

Governments issue emerging market bonds in developing countries. They are considered risky investments, as there is a higher chance the issuer won’t be able to make interest payments or return your principal. Emerging market bonds typically have maturities of 5 to 10 years.

Consult the Professionals

Investing in bonds can be a great way to diversify your portfolio and generate income. However, remember that there are risks involved. If you’re considering any new investments, our team can help you create a strategic plan to help balance your portfolio. Connect with us to schedule a complimentary consultation to learn more.

Investments in fixed income securities are subject to the creditworthiness of their issuers and interest rate risk.  As such, the net asset value of bond and real estate funds will fall as interest rates rise.

The principal value of bonds will fluctuate with market conditions. Bonds redeemed prior to maturity may be worth more or less than their original cost. Bond interest paid by a municipality outside the state in which you reside could be subject to state and local income taxes. If you sell a municipal bond at a profit, you could incur capital gains taxes. In some cases, municipal bond interest could be subject to the federal alternative minimum tax.

Investments in emerging markets involve heightened risks due to their smaller size, decreased liquidity and exposure to political turmoil or rapid changes in economic conditions not normally experienced by more developed countries.

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U.S. Government Securities are backed by the full faith and credit of the U.S. Government as to the timely payment of principal and interest. The principal value will fluctuate with changes in market conditions. If they are not held to maturity, they may be worth more or less than their original value.

A diversified portfolio does not assure a profit or protect against loss in a declining market.