Stocks get all the attention, but bonds are a huge part of the financial world—and probably should be part of your portfolio too. They're less exciting than stocks, but that's kind of the point.
What Is a Bond?
You're the Lender
A bond is essentially a loan. When you buy a bond, you're lending money to the issuer—a company, city, or government. In return, they promise to pay you interest and return your principal when the bond matures.
Think of it like being the bank. When you get a mortgage, the bank lends you money and you pay them interest. With bonds, you're the lender collecting interest from borrowers.
Key Bond Terms
The amount the bond will be worth at maturity, typically $1,000 per bond. This is what you'll get back when the bond matures.
The interest rate the bond pays, expressed as a percentage of face value. A 5% coupon on a $1,000 bond pays $50 per year.
When the bond expires and the issuer returns your principal. Could be months or decades away.
Your actual return, which depends on the price you pay. Different from coupon rate if you buy above or below face value.
Types of Bonds
Government Bonds
Treasury Bonds (T-Bonds)
Issued by the U.S. federal government. Considered the safest investments in the world because the government can always print money to pay you back. Maturities range from weeks (T-bills) to 30 years.
Municipal Bonds (Munis)
Issued by states, cities, and local governments. Interest is usually exempt from federal taxes—great for high earners.
I Bonds
Treasury bonds that adjust for inflation. Limited to $10,000 per person per year, but a solid option when inflation is high.
Corporate Bonds
Companies issue bonds to raise money for expansion, acquisitions, or refinancing debt. They pay higher interest than government bonds because there's more risk—companies can go bankrupt.
Agencies like Moody's, S&P, and Fitch rate bonds from AAA (safest) to D (in default). Anything BBB/Baa and above is "investment grade." Below that is "high yield" or "junk."
The Price-Yield Relationship
The Inverse Relationship
This concept confuses many people, but it's crucial: when bond prices go up, yields go down, and vice versa.
You buy a bond
$1,000 face value, 5% coupon = $50/year in interest
Interest rates rise
New bonds now pay 6%. Who wants your 5% bond?
Price must fall
At ~$833, your $50 payment = 6% yield to buyer
The inverse is also true. If rates fall to 4%, your 5% bond becomes more valuable because it pays more than new bonds. Its price rises.
Duration Risk
The longer a bond's maturity, the more sensitive it is to interest rate changes. A 30-year bond can swing wildly in price when rates move. A 2-year bond barely budges. This hammered bond investors in 2022 when the Fed rapidly raised rates.
How Bonds Make Money
Interest Income
The regular coupon payments. A $1,000 bond with a 5% coupon pays you $50 per year (usually in two $25 payments).
Price Appreciation
If you sell the bond before maturity for more than you paid, you pocket the difference. This happens when interest rates fall after you buy.
If you hold a bond until maturity, you get exactly what was promised: your interest payments plus your original principal back. Price fluctuations along the way don't matter if you don't sell.
Why Own Bonds?
Bonds serve several important purposes in a portfolio:
Stability
Less volatile than stocks. When the stock market crashes, bonds often hold steady or rise as investors seek safety.
Income
Regular interest payments. Unlike stock dividends, bond payments are contractually obligated.
Diversification
Bonds often move differently than stocks. When stocks zig, bonds sometimes zag. This reduces overall volatility.
Capital Preservation
If you need money at a specific future date, bonds can guarantee you'll have it. Stocks could be down 30%.
Risks of Bonds
Bonds are safer than stocks, but they're not risk-free:
How to Invest in Bonds
Individual Bonds
Buy through a broker or at TreasuryDirect.gov. You know exactly what you're getting and can hold to maturity.
Bond Funds (ETFs & Mutual Funds)
Most investors use these: BND, AGG, or TLT. Instant diversification, but you're always exposed to rate fluctuations.
Bond Ladders
Buy bonds with staggered maturities (1, 2, 3 years). As each matures, reinvest at the longest rung. Balances yield and flexibility.
Bonds in Your Portfolio
The classic advice was to hold your age in bonds (30 years old = 30% bonds). That's probably too conservative for most people today, but the principle stands: more bonds as you age.
Adjust based on your personal risk tolerance and timeline. Some people sleep better with more bonds regardless of age.
The Bottom Line
Bonds aren't exciting, and that's their value. They provide stability, income, and diversification when stocks get rocky. Understanding how they work—especially the price-yield relationship—helps you make smarter decisions about your allocation.
You don't need to become a bond expert. A simple total bond market fund covers the basics. But knowing what you own and why you own it makes you a better investor.