If you loan your cousin Gertrude $10 on January 1st and told her she would have to pay you back $11 on December 31st you might call this loan an IOU.
That’s what a bond is, an IOU.
Bonds are sold by corporations, municipalities and the U.S. government as a means of raising money. For example, if your local municipality needs to raise money to build a new city hall they may issue bonds to raise money for the construction. Bonds are a form of borrowing and from an investment perspective, you’re the lender.
When you purchase a bond you become one of many individuals loaning money to a corporation, or government institution. Bonds are often considered fixed income security because when you purchase a bond you know immediately what you are going to get as a rate of return.
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Here are the key points regarding Bonds.
- You make money from bonds based on the interest rate paid to you for purchasing a bond. The interest rate for a bond is typically called the bond yield. A bonds coupon rate is the annual interest paid on a bond.
- The interest rate or yield can be fixed or variable.
- Bonds have a maturity date – the date when you get all your money back. Bonds are generally grouped into categories. Short term bonds mature in five years or less. Intermediate bonds mature in 6-12 years, long term bonds may take 30 years to mature.
- The longer the term of the bond’s maturity date the higher the yield paid.
- Bonds can be purchased from many banks and brokers. U.S. Treasury bonds can be purchased directly from the U.S. government. Or you can invest in bonds through specific mutual funds that specialize in bonds as an investment vehicle.
- Bonds are generally sold in denominations of $1000 or $5000.
Some investment gurus view bonds a safer investment (bonds with a high credit rating) than stocks or mutual funds, that’s because you know what you’re going to get (rate of return) when you purchase them. Bonds are another way of diversifying an investment portfolio and may be found within investments you already have – like a mutual fund, 401(k) or IRA.
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- FTP Simple Investing eBook
Do you invest in Bonds? Comment below.