Bonds
A bond is a loan. You lend money to a government or a company, it pays you interest, called the coupon, and returns the original amount when the bond matures.
How you earn
Through the coupon payments and, if you hold to maturity, getting your money back. If you sell early you may get more or less than you paid, depending on where interest rates have gone.
The one rule to remember
When interest rates rise, existing bond prices fall, and when rates fall, prices rise. A bond paying 2% is worth less once new bonds pay 5%. The longer the bond, the bigger the effect. This sensitivity is called duration.
What moves the price
- Central bank policy and expectations for inflation.
- The borrower's credit quality. A weaker borrower must pay more.
- Supply. Large government deficits mean more bonds to sell.
- Demand for safety. In panics, investors often buy government bonds.
How it can hurt you
- Rising rates, especially for long-dated bonds.
- Inflation, which eats into fixed payments.
- Default, when the borrower cannot pay.
The rhyme
The bond rout of 2022Bonds are usually the calm part of a portfolio. In 2022, as the Federal Reserve raised rates from near zero at the fastest pace in four decades, the Bloomberg US Aggregate Bond Index lost about 13%, its worst year since the index began in 1976. The rhyme goes back to the late 1970s, when inflation pushed the US 10-year yield toward 16% by 1981 and bond investors called them "certificates of confiscation".
Terms you will hear
- Coupon
- The interest a bond pays, usually once or twice a year.
- Yield
- The return you get if you buy at today's price and hold to maturity.
- Duration
- How much a bond's price moves when rates change by one percentage point.
- Yield curve
- Yields across maturities. When short rates exceed long rates, the curve is inverted.
- Credit spread
- The extra yield a company pays over a government bond of the same length.
Educational content only. Not a recommendation to buy or sell. Past performance does not indicate future results.