Stocks and bonds. You hear people talking about these two important topics all the time. Do you understand exactly what they mean though? Sure, investments, but what type of investments. Understanding what you are (or aren’t) investing in it a key part of intelligent investing.
We already provided an easy answer to “What are stocks“, so now is the time to answer: What are bonds?
A bond is really just a loan
A bond is a loan to a company or organization from an investor.
So when you buy a bond or a fund that holds bonds, you are lending money to the issuer of the bond. Buy a bond from a company, say for $1,000, and you’re going to hand over the $1,000 loan amount. Then you’ll get fixed payments over the term of the loan equal to the interest rate offered. You’ll also get your $1,000 back at the end of the bond term.
The thousand dollars was loaned to the company, who paid back interest and the loan principal.
Bonds Provide Fixed Income
Bonds are considered “fixed income” investments because they have a set interest rate when they are originally issued.
While the bond’s interest rate never changes, sometimes the price of the bond does. That change in bond price impacts the return, or the effective rate, provided by the bond. (*Example lower in the post).
Even though the price of bonds do change, historically those fluctuations are WAY smaller than fluctuations in stock prices. This is why investors with lower risk tolerances often have a portion of their investment portfolio allocated to investment bonds.
Understanding Bonds and Risk
Bonds are generally conside