Investing Talk #3: Bond Investing
Bond investing is a way to earn income and preserve capital by lending money to governments, corporations, or municipalities in exchange for interest payments. Bonds are considered less risky than stocks, but they come with their own risks and rewards.
What Is a Bond?
A bond is a loan:
-
You (the investor) lend money to an issuer (government, corporation, etc.).
-
In return, they pay you regular interest (coupon).
-
At the maturity date, they repay your original amount (face/par value).
Basic Bond Terms
| Term | Meaning |
|---|---|
| Face Value | Amount paid back at maturity (usually $1,000) |
| Coupon Rate | Annual interest rate paid (e.g. 5%) |
| Yield | Actual return based on price paid |
| Maturity | When the bond expires (e.g. 2, 10, 30 years) |
| Issuer | Who is borrowing the money (e.g. U.S. Treasury, Apple) |
Why Invest in Bonds?
Pros:
-
Regular income (semiannual interest payments)
-
Lower risk than stocks (especially government bonds)
-
Diversification in your portfolio
-
Capital preservation (return of principal)
-
Some are tax-advantaged (e.g. municipal bonds)
Cons:
-
Inflation risk: Returns may not keep up with inflation
-
Interest rate risk: Bond prices fall when rates rise
-
Credit risk: Corporations or municipalities can default
-
Reinvestment risk: You may have to reinvest at lower rates
Types of Bonds
| Type | Description |
|---|---|
| Treasury Bonds | Issued by U.S. government; ultra-safe |
| Municipal Bonds | Issued by states/cities; often tax-free |
| Corporate Bonds | Issued by companies; higher yield, more risk |
| High-Yield Bonds | AKA “junk bonds”; very high risk/reward |
| Bond ETFs/Mutual Funds | Easy way to diversify bond holdings |
Bond vs. Stock
| Feature | Bond | Stock |
|---|---|---|
| Risk | Lower | Higher |
| Income | Fixed interest | Dividends (if any) |
| Ownership | Lender | Owner/shareholder |
| Return Type | Interest + principal | Capital gains + dividends |
Example: 5-Year Corporate Bond
-
Face value: $1,000
-
Coupon rate: 4%
-
Interest paid: $40/year for 5 years
-
Total return: $200 in interest + $1,000 principal back
If interest rates rise to 6%, the bond’s price may fall below $1,000 if you want to sell early.
When to Use Bonds in a Portfolio
-
As a stabilizer against stock market volatility
-
To generate income in retirement
-
To preserve wealth short- or medium-term
-
To balance risk when nearing financial goals
Rule of Thumb: Age-Based Allocation
Many advisors suggest:
“Your age = % of portfolio in bonds.”
-
At age 30: 30% bonds / 70% stocks
-
At age 60: 60% bonds / 40% stocks
Not a strict rule—depends on your risk tolerance and goals.
Bond Yield
1.1. Coupon Yield (Nominal Yield)
This is the fixed interest rate the bond pays based on its face value.
Formula:
Example: A bond with a $1,000 face value and 5% coupon pays $50/year.
Coupon yield = 5%
1.2. Current Yield
This is what you earn based on the price you paid, not the original face value.
Formula:
Example: If the same bond is now priced at $950:
So, you earn more than 5% if you buy below par.
1.3. Yield to Maturity (YTM)
This is the total return you'll earn if you hold the bond until it matures — including coupon payments and any gain/loss if you bought it at a discount or premium.
It considers:
-
Purchase price
-
Time to maturity
-
Coupon payments
-
Final repayment
YTM is the most accurate measure of a bond's profitability — but it requires more complex math or a calculator.
What Affects Bond Yields?
| Factor | Effect on Yield |
|---|---|
| 📉 Bond Price Falls | Yield goes up |
| 📈 Bond Price Rises | Yield goes down |
| 📊 Interest Rates Rise | New bonds offer more yield → prices of old bonds fall |
| 🧾 Credit Risk ↑ | Investors demand higher yields for more risk |
| 📆 Longer Maturity | Usually higher yield (more risk over time) |
Why Yields Matter to You
-
Higher yield ≠ better: A 10% bond might carry big risk (junk bonds).
-
Low yield ≠ bad: A 3% Treasury bond is very safe.
-
Yields help compare risk vs reward across investments.
Quick Yield Comparison
| Bond Type | Typical Yield (2025) | Risk Level |
|---|---|---|
| U.S. Treasury (10Y) | ~4.5–4.8% | Very low |
| Investment-Grade Corporate | ~5–6% | Moderate |
| High-Yield ("Junk") | ~8–12% | High |
| Municipal Bonds | ~3–5% (often tax-free) | Low–Moderate |