If you have been researching retirement saving or investing, I am sure you have came across the word, bond. The word bond, in investing, is a contract that states whomever you purchase the bond from, owes you more money in the future. Bonds are fixed income instruments, meaning you know they payment amount you will receive before you purchase the contract. When you purchase a bond, you are buying a company’s or government’s debt. The entity that you purchased the bond from usually pays the bondholder interest payments over a fixed period of time, and end the end, they pay you more than you purchased the bond for. There are many variations to bonds, but let’s go over some basics first.
Why do people buy bonds instead of other investments and securities?
Bonds are a great way to preserve wealth. When you purchase a bond with a face value of $1,000, when the bond matures, you will receive the face amount in addition to have received interest payments over the life of the bond. Bonds are wonderful for retired investors because they pay a coupon payment (interest payment) either semi annually or annually. This helps the bondholder to predict their income and not be too stressed about planning their expenses in retirement. Historically, bonds have held steady through the volatile stock market dips. This is another reason bonds are appealing to certain investors.
When you purchase corporate bonds, you are essentially giving the company a loan. Although if the company goes bankrupt, the odds of ever getting your money back are slim, bond holders of companies get paid back before common shareholders do. With that being said, do not buy a company’s bonds if you do not feel that the company will be profitable in the future.
Municipal bonds, or “munis,” are bonds that are issued by governments, such as cities or municipalities. Many times when a city want to improve their roads or bridges, they will issue these types of bonds to raise the funds necessary to complete the project. Municipal bonds perform like most bonds, however, the interest you earn on these financial instruments are not taxed. They are not taxed like corporate bonds to make them more appealing to investors and savers.
How do Bonds Work?
The interest rate a bond pays the bondholder is called the coupon rate. The coupon dates are set with the purchase of the bond, therefore, you will know when you are going to be receiving income. Coupon payments are normally paid annually or semi annually.
There is not just one type of bond. For instance, a “zero coupon” bond does not pay interest. Instead of regular interest payments, an investor purchases this type of bond at a discount of the face value. So, if the face value of the bond is $1,000, a company may offer bonds for $900. This means at maturity if the company is still making money and is able to pay its debt holders, the bondholder will receive a minimum of $1,000 per bond he has. Depending on the market, the face value of bonds can increase over their face value. This deals with interest rates at the time of purchase and maturity, we’ll get to that later.