Bonds
When you buy a bond, you are lending money to a company or government. They pay you interest, then give your money back at the end. It is the opposite of being in debt — you are the lender.
How Bonds Work
Think of a bond as an IOU. You give someone money, they promise to:
Pay you interest at regular intervals (usually every 6 months)
Give you your original investment back on a specific date (the maturity date)
Simple example:
You buy a $1,000 bond that pays 5% interest for 10 years. Every year, you receive $50 in interest. At the end of 10 years, you get your $1,000 back. Total: $1,500.
Types of Bonds
Loans to the US government. Considered the safest investment because the government can print money to pay you back.
Loans to state and local governments. Often exempt from federal taxes, making them attractive for high-income investors.
Loans to large, stable companies. Higher returns than government bonds, but companies can fail.
Loans to riskier companies. Much higher interest rates because there is a real chance of not getting paid back.
Why People Choose Bonds
Bonds are generally less volatile than stocks. You know exactly how much you will receive and when, assuming the borrower does not default.
Interest payments come on a regular schedule. This is valuable for retirees or anyone who needs steady income from their investments.
The Trade-Off
Lower risk = lower returns
Bonds typically return 3-6% per year, while stocks have historically returned about 10%. Over decades, this difference compounds significantly. A portfolio that is all bonds will be safer but will grow much more slowly.
Bonds Are Not Risk-Free
Lower risk is not the same as no risk. Bonds have their own dangers:
Default risk: The borrower might not pay you back (more likely with corporate/junk bonds)
Interest rate risk: If rates rise, existing bonds become less valuable
Inflation risk: If inflation is higher than your bond's interest rate, you lose purchasing power
When Bonds Make Sense
You are getting closer to retirement and want to reduce risk
You need predictable income from your investments
You want to balance out the volatility of stocks in your portfolio
You have short-term goals (5 years or less) where you cannot afford a stock crash
Key Takeaway
Bonds are the "slow and steady" part of investing. They will not make you rich, but they provide stability. Most people should have some bonds, with the percentage increasing as they get older. A common rule: your age = the percentage of bonds in your portfolio (though this is just a starting point).