What is a bond?
What is a bond?
- Corporate bonds are debt instruments issued by corporations to finance their operations or expansion.
- Municipal bonds, also called muni bonds, are debt issued by states, cities, and other local government entities to fund public projects or provide services to the public.
- Treasury bonds, also called T-bonds, are issued by the U.S. government to fund its operations or refinance existing debt.
In return for loaning them the money, the bond issuer pays interest to the holder at a specified rate until the bond matures. Bonds are interest-only loans. The borrower makes interest payments (usually biannually) on the principal balance, allowing the investor to earn a predictable passive income stream.
Why should investors own bonds?
Why should investors own bonds?Bonds provide investors with three benefits:
- They supply a predictable income stream from interest payments.
- They allow investors to preserve capital if they hold the bond to maturity, at which time they receive their principal back.
- They help an investor diversify their portfolio and offset some stock market volatility.
|Aspect||100% Fixed Income||60/40 Portfolio||100% Equity|
|Average annual return||5.3%||8.8%||10.3%|
|Years with a loss||14 of 94||22 of 94||26 of 94|
Bonds rated investment-grade carry a lower default risk than bonds that are not rated investment-grade, which are known as junk bonds. Investors need to do their due diligence before adding bonds to their portfolios.
ETF vs. Index Fund: What Are the Differences?Your investment style can dictate which kind of fund is best for your portfolio.
How to add bonds to your portfolio
How to add bonds to your portfolioAdding bonds can help reduce a portfolio's risk profile. They can also supply income. Many people like to increase their portfolio's allocation to bonds as they approach or enter retirement.Investors have two ways to add bonds to their portfolios:
- Buy bonds directly: Investors can research and buy bonds through their brokerage account. They can also buy T-bonds directly from the U.S. government at TreasuryDirect.gov. Investors need to understand the bond's issuer credit rating, maturity date, and interest rate when purchasing bonds directly to ensure they align with their risk profile and goals.
- Invest in a bond fund: An easier option for beginners to add bonds to their portfolio is investing in a mutual fund or exchange-traded fund (ETF) focused on bonds. There are many available bond funds. Some offer broad exposure to the bond market, while others focus on different aspects of bond investing, including yield, issuer, and maturity date. Bond funds charge an expense ratio to manage the fund for investors. A lower expense ratio enables the investor to keep more of the fund's return.