Even though stocks and bonds are often mentioned together, they have little in common. While stock represents ownership in a company, a bond represents a debt obligation. In general, bonds offer less surprises than stocks. Historically, they also offer much smaller gains compared to stocks over a long period of time.
A bond is essentially an IOU that the borrower promises to repay at the time when the bond matures. In the mean time, bonds also pay at a fixed interest rate, also known as coupon rate, usually semiannually.
Bonds are often categorized based on the type of bond issuer:
- Government Bonds. Bonds issued by the US government are also called Treasures and are considered one of the safest types of investments.
- Municipal Bonds. Not as safe as the Treasures, but often provide better after-tax yields.
- Corporate Bonds.Companies use bonds to borrow money short- and long-term. The corporate bonds are generally riskier than the Treasures since even the largest and most stable companies sometimes may find it difficult to pay their debts. On the bright side, corporate bonds will have relatively high coupon rates in order to compensate for the additional risk.
Since bond investing can get rather complicated, many people who are not particularly interested in following the bond markets invest in bond mutual funds instead. Even though buying shares in a bond mutual fund is not the same as buying bonds, it can be useful as a portfolio diversification tool.
The following quiz deals with some basic concepts of bond investing.
Note: To obtain financial advice, please contact a qualified professional.
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