What is a Bond?
A bond is essentially a loan you make to a government or corporation. In return, the issuer pays you regular interest (the coupon) and returns your principal at maturity. A 10-year US Treasury bond with a 4% coupon and $1,000 face value pays $40 annually and returns $1,000 after 10 years. Bonds are generally less volatile than stocks but offer lower long-term returns.
Bond Prices and Interest Rates
Bond prices move inversely to interest rates. When rates rise, existing bond prices fall because new bonds offer higher yields. A 1% rate increase causes a 10-year bond to lose approximately 8-9% of its value. Shorter-duration bonds are less sensitive to rate changes. This inverse relationship makes bonds a useful diversifier against stocks in many market environments.
Key Considerations
Government bonds from stable countries are among the safest investments but may not keep pace with inflation. Corporate bonds offer higher yields but carry credit risk - the possibility the issuer defaults. For most individual investors, a diversified bond index fund is preferable to selecting individual bonds, as it spreads credit risk across hundreds of issuers.