What You Need To Know About Bond Investment

If you plan to invest in stocks, you should as well know about bonds. Bonds can save your investment portfolio in troubled times. Bonds may not look as fancy as stocks or commodities, but they can become a significant component among your investments. A bond is a debt security, in which the issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon). In other words, a bond is an IOU issued by a corporation, government, or governmental agency to cover money the bondholder has lent. A bond is just like a loan. The issuer is equivalent to the borrower, the bond holder to the lender and the coupon to the interest. Bonds enable the issuer to finance long-term investments with external funds.

To understand bonds you need to know some basic concepts: Par value, also known as face or principal value, is how much the bondholder will receive at maturity. A $2,500 par value bond will be worth $2,500 when it matures. Coupon, which is a fixed annual rate the bond pays. It is called the coupon rate because bonds once came with a book of coupons, which the holder had to clip and send in to receive an interest payment. Maturity refers to the length of time before the par value is returned to the bondholder. It may be as short as a few months, 30 years, or more. At maturity, the bondholder receives the par value of the bond.

Why invest in bonds? Bonds are part of every well-balanced investment portfolio and they can help you diversify it. The difference between bonds and stocks is that stock holders own a part of the issuing company (have an equity stake), whereas bond holders are in essence lenders to the issuer. Returns from stocks are generally higher than bonds; however, bonds are a much safer investment. Bonds safety and stability act as a counter to the fluctuations that stocks suffer. You can buy or sell bonds in the open market as you would with stocks and other securities. As a result, bonds fluctuate in price, selling at a premium (above) or discount (below) to its face value (par value). Generally, the longer a bond's duration to maturity, the more its price can fluctuate. These factors expose bonds to certain risks.

It's a good idea to always keep an eye on your bond portfolio as you would with other investments. Interest rates tend to affect a bond's current yield, which measures the coupon rate of your bond in relation to its current price. The current yield rises with a corresponding drop in the price of a bond, and vice versa. Also, government fiscal policy, inflation, and corporate finances can affect bond prices.

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What You Need To Know About Bond Investment