Bond

Also called Fixed-income security

A loan an investor makes to a government or company, which promises to pay interest and return the face value on a set maturity date.

What it means

When you buy a bond, you are lending money. The issuer usually pays a fixed interest amount, called the coupon, on a schedule, then repays the face value at maturity. Investors earn the interest and can also gain or lose if they sell before maturity, because bond prices move opposite to interest rates: when rates rise, existing bonds with lower coupons lose market value.

The main risks are interest rate risk, credit risk (the issuer may miss payments or default), and inflation risk (fixed payments buy less over time). Bonds have historically been less volatile than stocks but have usually grown more slowly. Taxes depend on the issuer: corporate bond interest is taxed as ordinary income, Treasury interest is exempt from state and local tax, and most municipal bond interest is exempt from federal tax.

Example

For example, a $1,000 bond with a 5% coupon paid twice a year pays $25 every six months. Over 10 years that is 20 payments, or $500 of interest, and the $1,000 is repaid at the end if the issuer does not default.

How it’s used

Generating steady income, often in or near retirement
Balancing the swings of stocks in a portfolio
Saving for a known future expense with a matching maturity date

Strengths and weaknesses

Strengths

Predictable interest payments if held to maturity
Historically less volatile than stocks
Wide choice of issuers, maturities and tax treatments

Weaknesses

Market value falls when interest rates rise
Issuer can default, especially with lower-rated bonds
Fixed payments lose purchasing power to inflation

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.