What Are Bonds?
When you buy a bond, you're essentially lending money. The borrower (government, corporation, or municipality) promises to pay you a fixed interest rate (called the coupon) and return your principal when the bond matures.
Bonds are called "fixed income" because they provide predictable, regular interest payments. This makes them essential for retirees, conservative investors, and anyone who needs portfolio stability.
Types of Bonds
Government Bonds
- Treasury Bills (T-Bills): Mature in 4-52 weeks. No coupon; sold at a discount.
- Treasury Notes: 2-10 year maturities. Pay semi-annual interest.
- Treasury Bonds: 20-30 year maturities. Highest duration risk but higher yields.
- TIPS: Treasury Inflation-Protected Securities. Principal adjusts with inflation.
- I Bonds: Savings bonds with inflation protection. Max $10,000/year. See current rates.
Corporate Bonds
Issued by companies. Higher yields than Treasuries but more risk. Rated by agencies (Moody's, S&P, Fitch) from AAA (highest quality) to C/D (junk/default).
- Investment Grade: BBB- or higher. Lower risk, lower yield.
- High Yield (Junk): BB+ or lower. Higher risk, higher yield (6-10%+).
Municipal Bonds
Issued by state and local governments. Interest is typically exempt from federal taxes and often state taxes too. Attractive for high-income investors.
How Bond Yields Work
Bond prices and yields have an inverse relationship. When interest rates rise, existing bond prices fall. When rates fall, bond prices rise. This is the most important concept in bond investing.
The yield curve shows yields across different maturities. A normal curve slopes upward (longer maturities = higher yields). An inverted curve (short-term yields higher than long-term) often predicts recessions.
How to Invest in Bonds
- Bond ETFs: Easiest approach. BND (Total Bond), TLT (Long Treasury), HYG (High Yield). Trade like stocks.
- Individual Bonds: Buy through your brokerage. Treasury bonds at TreasuryDirect.gov.
- Bond Mutual Funds: Actively managed, priced daily. Higher fees than ETFs.
- I Bonds: Buy at TreasuryDirect.gov. $10,000/year limit. Great inflation hedge.
Bonds in Your Portfolio
Bonds reduce portfolio volatility and provide income. Common allocations:
- Aggressive (age 20-35): 10-20% bonds
- Moderate (age 35-50): 30-40% bonds
- Conservative (age 50-65): 40-60% bonds
- Retired (65+): 50-70% bonds