Bond Investing Basics
Bonds are IOUs that pay interest. They're the boring-but-important part of most portfolios. Here's what you need to know.
What Is a Bond?
A bond is a loan you make to a government or corporation. They pay you interest (the "coupon") and return your principal at maturity. Bonds are generally less risky than stocks but offer lower returns.
Bond Basics
Face Value (Par)
The amount the bond will pay at maturity—typically $1,000 per bond.
Coupon Rate
The interest rate, expressed annually. A 5% coupon on a $1,000 bond pays $50/year.
Maturity
When the bond expires and principal is returned. Short-term (1-3 years), intermediate (3-10 years), or long-term (10+ years).
Yield
Your actual return based on current price. If a 5% coupon bond trades at $900, your yield is higher than 5%.
Types of Bonds
Treasury Bonds (Safest)
Issued by US government. Virtually no default risk. Interest exempt from state/local taxes.
- T-Bills: Under 1 year
- T-Notes: 2-10 years
- T-Bonds: 20-30 years
- I-Bonds: Inflation-protected (buy at TreasuryDirect.gov)
Municipal Bonds
Issued by state/local governments. Interest often tax-free federally (and sometimes state). Best for high-tax-bracket investors.
Corporate Bonds
Issued by companies. Higher yields than government bonds, but higher default risk. Rated by agencies (AAA = safest, junk = riskiest).
Bond ETFs (Easiest Way to Invest)
| ETF | Focus | Yield | Expense |
|---|---|---|---|
| BND | Total US Bond Market | ~4.5% | 0.03% |
| AGG | Total US Bond Market | ~4.5% | 0.03% |
| SHY | Short-Term Treasury | ~4.5% | 0.15% |
| TLT | Long-Term Treasury | ~4.5% | 0.15% |
| MUB | Municipal Bonds | ~3.5%* | 0.07% |
| LQD | Investment-Grade Corporate | ~5.0% | 0.14% |
*Tax-equivalent yield higher for high-bracket investors
Interest Rate Risk
When interest rates rise, bond prices fall (and vice versa). Long-term bonds are more sensitive than short-term bonds.
Example: If you own a 4% bond and new bonds pay 5%, who wants your 4% bond? Its price drops until the yield matches.
How Much Bonds?
Classic rule: Your age in bonds (30 years old = 30% bonds). Modern thinking often suggests less, especially for young investors with long time horizons.
- Young (20s-30s): 0-20% bonds
- Mid-career (40s-50s): 20-40% bonds
- Near retirement (60+): 40-60% bonds
Bonds vs. Bond Funds
Individual Bonds
- Hold to maturity = guaranteed return of principal
- Requires larger investment to diversify
- More work to manage
Bond ETFs/Funds
- Instant diversification
- No maturity date (ongoing buying/selling)
- Can lose principal if rates rise
- Much simpler for most investors
The Bottom Line
Bonds provide stability and income. They're the ballast that keeps your portfolio from capsizing in stock market storms.
For most investors, a simple bond ETF like BND or AGG provides diversified fixed-income exposure at minimal cost. Adjust your allocation based on age, risk tolerance, and time horizon.
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