Bonds are essentially loans to the government or a company on which you earn interest, and the issuer promises to pay you
back in full by a certain date. Government bonds offer the greatest degree of security, as they are backed by the "full
faith and credit" of the relevant Government. It's highly unlikely that the Government will default on repayment
of this loan!
Bonds are generally referred to as "fixed-income investments" because they make regular
interest payments up until the date of maturity. The longer a bond's maturity, the more its price will be affected by
fluctuating interest rates. To compensate for the greater price risk, long-term bonds generally offer higher interest rates
than intermediate or short-term bonds.
Over time, bonds have generally proven to provide higher returns than cash
investments and to perform ahead of inflation, but are a more conservative investment than stocks.
The key benefit
of bonds is income, which is usually paid every 6 months. Bond prices can fluctuate from day to day, but the income stream
they provide may be very attractive for long-term investors. Bond prices typically move in the opposite direction from interest
rates - when interest rates rise, bond prices drop, and vice versa.
There are a few different types of bonds:
should always consider the bond's safety, term, and interest rate prior to making any investment decisions.
- Government: Secured by the Government and considered quite safe.
Issued by publicly traded companies.
- Municipal: Issued by states and local governments, the income
earned is exempt from federal taxes and in some states, exempt from state taxes.
- High-yield: Also
referred to as "junk bonds" as they are speculative, high-risk, high-interest rate corporate or municipal bonds.