What are bonds?


Ryland Goldman - Sunday, May 2nd, 2021

Stocks are a good way to make money, but they can also lose value pretty easily if something bad happens. One way to make sure you don't lose a lot of money is to diversify using bonds.

Bonds are pretty simple: they're just loans. If you buy a bond from the U.S. government, called a Treasury bond, you are loaning money to them, and your profit is the interest on the loan.

You purchase a bond at a certain price, known as face value. When the bond matures, or reaches its end, the loan is paid back and you get the face value back. During the period until then, you recieve interest payments.

The risk of owning bonds is that it might not be paid back. The risk of this, known as defaulting, is shown as a credit rating, where AAA or Aaa bonds are the least likely to default, and D or C bonds very high likelyhood. The worse the credit rating and the longer the time until maturity, the higher yield it normally has compared to similar bonds.

Bonds have lower risk because loans get paid back in full if held to maturity (unless they default), while stocks can drop and never recover. Let's look at some types of bonds:


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U.S. Treasury Bond
Treasury bonds are bonds that are issued by the United States government. Their credit rating is one of the highest, but because of this you don't make a lot of money. If you hold a treasury bond for 30 years, you only make a 2.3% return on your investment. However, it is very unlikely that you will lose money from defaulting, because they are considered very low-risk investments.


Municipal Bond
Municipal bonds are special in the sense that you normally don't have to pay state tax, and sometimes federal tax, on the money you make from them. They are issued by counties and states. They have lower yields than other bonds because they aren't subject to income tax.


Corporate Bond (investment-grade)
Investment-grade corporate bonds are from corporations. Most companies, from Johnson & Johnson to General Electric, issue bonds as a way to get money for their operations. Some of them are risker than others, so pay attention to the ratings on them.


Corporate Bond (high-yield)
High-yield corporate bonds are corporate bonds that have a low credit rating. They have a much higher chance of default, but as the name suggests, pay more in yield.


Next article: What are commodities?