What Are Bonds, and Should You Invest in Them?

You can't have failed to chance upon information about how investing in bonds can be a popular way to go these days. If you're wondering about the opportunity presented by bonds, this little discussion should help you out. Let's start with the basics first – what are bonds.

A bond is basically investing in debt with a business company. In plain language, it is when you lend a business some money, and they agree to pay you interest to a set percentage for the money . Basically, a bond is the certificate or the IOU that the company (technically, called the issuer) gives you to acknowledge that it does owe you something. The rate at which they pay you interest, is called the coupon rate.

It isn't just businesses that issue bonds for money though. The government does it too, and so do municipalities and other entities. The loan that you make a company or other bond issuer is usually for a limited period of time. The day the period of the bond expires, they say that it has matured, and the company gives you your money back.

Of course, understanding what are bonds and understanding all the jargon that you'll come across investing in them are two different matters.

You don't have to hang on to a bond for as long as it takes to mature. Bonds trade like shares on the market too. If a company is a particularly dependable or otherwise well-respected place to park your money in, other people will want to buy your bonds and you can sell your holdings to them. You won't sell them at the price you bought them for though. You can sell them for many times what you paid for them. So the price of a bond isn't a stable thing.

The interest rate on a bond is what you get paid regularly for as long as the bond is yours. But what they pay you isn't usually a fixed thing. Often, they issue bonds with floating rates. This is where they peg your interest rates to some kind of market benchmark like the London Interbank Offered Rate.

When you're just trying to figure out what are bonds, it can often be difficult to understand jargon like "bond yield" that's thrown about. It isn't that difficult, actually. The yield of a bond is kind of percentage number that you use to compare one bond with the next. For instance, how do you compare bonds from one company with bonds from another when they cost different sums to buy in the first place?

Well, you compare them with the bond yield figure. You take the amount of interest you are paid every year and divide that by what the bond costs to buy. All things remaining equal, high interest together with low price will mean high yield. Low interest together with high price will mean the low yield.

So how good are bonds as an investment for your money? Well, if you're planning on retiring with your investments, you should know that bonds can be a great, safe money parking tool. They are less risky than stocks. But you should only put a part of your money in bonds – for safety's sake. The rest, should be a judicious mixture of mutual funds and stocks.