What Exactly Are Bonds and How Do They Work? - dummies (2024)

FAQs

What is a bond and how does it work for dummies? ›

Bonds are issued by governments and corporations when they want to raise money. By buying a bond, you're giving the issuer a loan, and they agree to pay you back the face value of the loan on a specific date, and to pay you periodic interest payments along the way, usually twice a year.

A bond is a fixed-income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental). A bond could be thought of as an I.O.U. between the lender and borrower that includes the details of the loan and its payments.

The bills, like savings bonds, are sold at a discount from their face value. You get the full amount when the bill matures. The notes and bonds, on the other hand, are sold at their face value, have a fixed interest rate, and kick off interest payments once every six months.

When you invest in a bond you will be allocated a certain number of units in the funds of your choice or those set out by the conditions of the bond. You can choose to invest in a range of funds, a portfolio, or a mixture of both. You can also usually switch between funds within your bond.

Historically, bonds are less volatile than stocks.

Bond prices will fluctuate, but overall these investments are more stable, compared to other investments. “Bonds can bring stability, in part because their market prices have been more stable than stocks over long time periods,” says Alvarado.

A bond is simply a loan taken out by a company. Instead of going to a bank, the company gets the money from investors who buy its bonds. In exchange for the capital, the company pays an interest coupon, which is the annual interest rate paid on a bond expressed as a percentage of the face value.

Because bond prices typically rise when interest rates fall, the best way to earn a high total return from a bond or bond fund is to buy it when interest rates are high but about to come down.

The most liquid bonds on the market are U.S. Treasury bills, or T-bills. These possess excellent credit ratings and strong liquidity thanks to their widespread use as collateral. You can access T-bills via an ETF like BIL, which charges a 0.14% expense ratio and pays a 5.3% yield to maturity.

What is the difference between a bond and a bill in the Treasury? ›

U.S. savings bonds are a long-term choice and are appropriate for savers looking at a 20-year or 30-year time horizon. Treasury bills are a short-term alternative, maturing in a year or less. Treasury notes are at the midpoint, maturing in two to 10 years. U.S. Department of the Treasury.

Use the Education Exclusion

You can skip paying taxes on interest earned with Series EE and Series I savings bonds if you're using the money to pay for qualified higher education costs. That includes expenses you pay for yourself, your spouse or a qualified dependent.

You can cash in all or part of your Bonds at any time.

You can only cash bonds that you own or co-own unless you have legal evidence or other documentation that we accept to show you are entitled to cash the bond. How do I know how much my bond is worth? Use our Savings Bond Calculator.

This is a rule in tax law which allows investors to withdraw up to 5% of their investment into a bond, each policy year, without incurring an immediate tax charge.

You can lose money on a bond if you sell it before the maturity date for less than you paid or if the issuer defaults on their payments. Before you invest. Often…

For example, a $1,000 bond with a coupon of 7% pays $70 a year. Typically these interest payments will be semiannual, meaning the investor will receive $35 twice a year.

Bonds are generally issued with fixed par values and stated coupon rates. The coupon rate determines the annual interest payments to be paid to the bondholder and are based off of the bond's par value. Interest payments are usually paid every six months.