Investing in Bonds

Tess Davenport
November 16, 2021

There are 4 types of investments that are great for beginner investors:

What are bonds?

When companies or governments need capital (money), they can issue bonds.

A bond is an IOU (I owe you) between a company or government and you, the investor.

You are loaning them money. The sum of money is called the principal.

The loan is for a set period of time. During which the company or government will pay interest payments called yields.

When the bond reaches maturity (the end of the loan period), the principal (the original sum) is returned to the investor.

How can you profit from investing in bonds?

For the average investor, there are two ways to make money with bonds:

  1. A coupon-paying bond pays the investor a set amount of interest. This is usually a percentage of the bond value and paid twice a year. Investors make money through these interest payments.
  2. A zero-coupon bond does not pay any annual interest. Instead you buy the bond at a discount, and when it reaches maturity, you sell the bond at its face value.

Benefits of investing in bonds

Low volatility

Bonds are relatively safe compared to other investments. In other words, the value of returns is more stable, so there is reduced risk involved.

Steady income

Coupon-paying bonds are a great way of securing a steady, passive income (money that you do not have to work for). They are particularly popular with retirees, as an alternative to a 401k or a retirement plan.

Inheritance and tax benefits

You can use zero-coupon bonds as a vehicle to pass down inheritance without paying as much tax. Some types of bonds in certain locations can offer other tax benefits.  

Varying lengths of maturity

Different bonds offer varying time lengths. From short-term (1 — 2 years) to more long-term holds (10 — 15+ years).

Negatives of investing in bonds

Read the fine print

Every bond will have a different set of characteristics: length of time, interest rate, insurance, tax status.

It’s important to know exactly what you’re getting yourself into.

Relatively low returns

While bonds offer low risk, the average return (profit) on bonds is often lower than for stocks, for example.

Your capital isn’t always guaranteed

There is always the risk that the company or bond issuer will default on the interest you’re owed or be unable to pay it.

Make sure to check if the bond is being guaranteed by a government approved company.