How do bonds work?
Bonds can play a useful role in almost any investor's portfolio, but many people find them a little confusing.
In essence, a bond represents a loan made to a corporation or public agency. Investors earn income through the interest paid by bond issuers—the borrowers—but several other factors determine how well a bond performs on the open market. Their historical track record has given bonds a reputation as relatively stable and conservative investments.
For most investors, bond funds may prove to be more practical than individual bonds. Such funds typically invest in corporate, municipal, or U.S. government debt, and most focus on income rather than investment growth.
We've created several interactive illustrations to take away some of the mystery around bonds and bond funds:
- Duration. How do time and interest rates affect a bond's value? Find out »
- Maturity and stability. In a bond fund, what's the relationship between maturity and price during a time of changing interest rates? Find out »
- Yield curve. People often talk about the yield curve and its impact on bond performance—what does this mean? Find out »
- All investing is subject to risk, including the possible loss of principal.
- Investments in bonds are subject to interest rate, credit, and inflation risk.
- Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.