Understanding Bonds

With looming budget decisions, investing in bonds may be last on an American’s mind. Keep faith, though, that bonds may be one of the best outlets for investment available to the American people today. What makes bonds so great, you’re asking? Let me tell you all you need to know about bonds and investing in them.

What is a bond?

Bonds do come in many shapes and sizes; some adjust to your income, some have fixed payments for 30 + years, some have fixed interest, but all are formal contracts, or debt security, to repay borrowed money with interest at fixed intervals. Unlike a loan, however, you’re not the one paying it back. Rather, bonds are a way for a company or government to invest in itself or raise money by selling IOUs (to put it most plainly).

How do they work?

Let’s say a hypothetical company contracts a bond up for sale. You buy that bond for, say, $1,000.00. In buying the bond you enter an agreement with the company: they are contracted to pay the bond back in 10, 20, or up to 30 years. Let’s choose two payments annually over the course of ten years and make this math easy. In the meantime, the company will pay interest, let’s say 5% interest, until the end of the period agreed upon. So, by the end of the ten year period, assuming you’ve held onto your bond and the company was financially stable, you would have made a total of $1,638.62 in 20 payments (remember: bi-annually). Congratulations, now you can invest!

I bought a bond, but now I don’t want it! What should I do?

That’s great! You may not have known this before, but unlike loans (I’d love to trade mine!), bonds are highly tradable. If you buy a bond from an established company (after considerable research, of course), most likely, there is a market to trade that bond. Meaning, you can sell the bond after five years of having it rather than waiting the full ten years. Make sure to tell people who ask not that you sold it because you needed the cash, rather, you are “building your portfolio.”

What if I lose all of my money investing?

Firstly, don’t invest all of your money. Investing isn’t a game, it’s much more calculated risk and benefits. Just as there is no such thing as free lunch, there is no such thing as a guaranteed investment, so there are some risks to be aware of:

Bond prices can vary. You can only be certain you’ll get back the face value of the bond if you hold on to it for the duration of the contracted repayment period.

You may not get your money back from the company or government that issued the bond. This is a risk that can, in most cases, be relatively calculated because some companies and governments are more financially stable than others.

So, essentially, if a company goes bankrupt, you may not get all of your investment back, but take solace in the fact that there is less risk of losing all of your money than there is for stockholders. Bond-holders receive payments sooner than stock holders.