The Fundamentals of Investing in Bonds

Bond Basics

Bonds 101: Basic information about Bonds. Bonds are a conservative way to invest.  However, these investments can also be a good way to invest in a savings or trust for children, retirement, or college fund.  Learning how to make money from bonds can quickly become a lucrative operation to make extra money.  There is nothing like investing $200 to $300 and receiving $1000 back.  In a low interest economy, now is the time to be investing in bonds.  Below are basic questions covering the fundamentals of bonds.  If you are serious about investing after reading, research the types of bonds you want to invest and establish a plan. 

 What is a bond?

A bond is like an “I owe you.” In other words, you agree to lend money to the bond issuer, usually a company, country or city, for a specific period of time.  The issuer agrees to pay you, the lender, interest on the loan amount, as well as the original amount of the loan when the bond comes due. 

How do I make money with a bond?

The most obvious way you make money from a bond is through the interest on the original amount of the loan.  However, you may also earn or lose money from the fluctuating price over the term of the bond.  Combining both of these variables equal your total return or earnings from the bond. 

How do rates affect the price of the bond?

The price of a bond changes and moves in the opposite direction of the market interest rates.  When the market rates decrease, the price of your bond increases.  Conversely, when market rates increase, your bond’s price falls.  For example, if you own a bond paying 2 percent interest and the interest rates have increased to 3 percent, you will not receive full price for your bond.  However, if interest rates fall less than 2 percent, you will most likely receive full price plus profit from your bond.

How are bonds traded? 

The majority of bonds are not traded on large open exchanges, such as the New York Stock Exchange.  Rather, bonds are primarily bought and sold through dealers.  Bonds do not trade as frequently as stocks are traded.  In fact, most bonds change dealers’ hands less than once a month.  Unfortunately, in comparison to stock exchange, the lack of liquidity from bond trading can cause volatile bond prices in a panic.

What are other types of lucrative bonds?

A bond mutual fund, a conglomerate of funds from several investors, or an exchange-traded fund, a security tracking an index like a stock, is arguably the best way to get satisfactory diversification. This may increase your odds of getting a better price.  However, because mutual funds or exchange-traded funds encompass a myriad of different bonds without a single maturity date, increasing interest rates can cause more harm or loss than a traditional individual bond.  Unless the issuer defaults, holding your individual bond to term will ensure you get your original investment back.