What are bonds? Government, corporate and municipal bonds are how capital projects are often financed. The US bond market is much larger than the stock market, so it's one way to add to your savings. Bonds...
Bonds are issued by governments, they are issued by corporations, state governments often issues bonds, and there are also tax free bonds. You give your money to any of these entities and they are going to give you a fixed level of interest for a specified period of time and at the end of that time, your principal should come back to you, so you become a creditor of that entity.
Bonds finance projects and build capital, but they owe you that money and they are going to pay you a certain fixed expense. For them it is an expense and for you it is just money coming in, but many people don't realize the size and scope of the bond market. Since the stock market is always a focal point, everyone talks about that. The bond market ironically is almost double the size of the US stock market -- actually several trillion dollars larger than the stock market. But bonds do have risks. For example, organizations issue bonds and they can go out of business. With government bonds, you are still the first in line to collect your money from the government. For the most part, bonds are analyzed by independent outside agencies and then rated. It helps investors get a handle on the safety of that bond investment, but the ratings do change depending on the financial health of that organization. Bonds can move up and down in price every day. The price depends on the interest rates. So for example, if you own a $1,000 bond to pay 5 percent interest for five years, you know that the bond is going to provide your current income stream with $50 a year. That income stream should remain stable throughout the whole life of the bond for five years, but that bond price, which you paid at $1000 is going to fluctuate on interest rates of bonds issued in the future. So, if you go back to the $1,000 bond at 5 percent, all things being equal, if another five-year bond is paying 7 percent, then it is going to make your bond less valuable if you decide to sell it at that time- because why would I buy a 5 percent bond when I can get 7 percent? You have to realize that bonds do have risk, but if you hold them until maturity, you should get all your principal back. When you think about it, these bonds really don't grow, so for the most part, you're not really going to keep up with inflation. You may take on less risk because you are getting guarantees on your income, but you are also not going to get really any appreciation as well.
