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Bond Basics For Beginning Investors

Your boss surprised you with a bonus, you sold your first novel, inherited some money from a relative, or got a big tax refund — whatever the reason, you have some cash to spare and you would like to invest it. The problem is, you know zero about investing.

Where do you even begin when you have a just little bit extra, but not enough to make you appealing to a financial advisor who can tell you where best to invest? You have numerous options, from mutual funds to individual stocks, but let’s start with something really basic — bonds.

Your grandparents probably had a few bonds, and maybe even swore by them. But as Investopedia notes, modern perception is that bonds “lack sex appeal.” While other investment vehicles like stocks can soar when the stock market — and overall economy — is doing well, bonds plug along accumulating interest at a steady, predictable rate. Yes, that reliability makes it hard to score a big payout from bonds, but it also means bonds are generally less risky than some other types of investments.

What is a bond?

When a government or company needs to borrow money, one of the ways it can do so is to offer bonds, and the borrowing organization might decide to issue bonds if it needs more money than a bank might typically loan. Investors like you — and thousands of others — buy those bonds on a public market, thereby “loaning” the organization the money it needs.

In return, the bond issuer agrees to repay the investor the principle that he or she invested plus interest. The full repayment is due on the bond’s maturity date.

How much can you make?

Historically, bonds don’t pay a huge amount of interest. Remember, they’re not the rock stars of the investment world. There are different types of bonds and depending on what kind you invest in your rate or return might be anywhere from 2-8%. So for an investment of $1,000, if you buy a bond with a 2% interest rate, you’ll make $20 a year until the bond reaches maturity.

So why would you want to buy bonds?

If you don’t have a lot to invest, you may not be able to get into a mutual fund or individual stocks, but you can probably still afford a bond. You can buy bonds for very small increments of money!

While bonds don’t come with the hefty payouts you might get from investing in the stock market, they do still pay significantly better than the average savings account, money market account, or CD. So you might make more on your extra $1,000 by putting it in a bond than if you were to just leave it sitting in your savings account.

The big thing bonds have going for them — especially government-backed bonds — is their security. They’re considered a fixed-income security because there’s no mystery and little risk — the day you buy the bond, you’ll know exactly how much money your investment will make. There’s also little risk of losing the principle, as opposed to the higher level or risk associated with stocks and even mutual funds.

Bonds might never leave you breathless with excitement or make you rich, but they can be a reliable, predictable way to help a little bit of money grow a little bit faster.

Tags: Personal Finance