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Most of us are used to borrowing money in some capacity, whether it's mortgaging our homes or bumming a few bucks off a friend. Similarly, companies, municipalities, and the federal government borrow money, too. How? By issuing bonds.
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Bonds are a way for an organization to raise money. Let's say your town asks you for a certain investment of money. In exchange, your town promises to pay you back that investment, plus interest, over a specified period of time.
For example, you might buy a 10-year, $10,000 bond paying 3% interest. Your town, in exchange, will promise to pay you interest on that $10,000 every six months, and then return your $10,000 after 10 years.
There are two ways to make money by investing in bonds.
Bond funds take money from many different investors and pool it all together for a fund manager to handle. Usually this means the fund manager uses the money to buy a wide assortment of individual bonds. Investing in bond funds is even safer than owning individual bonds.
Bonds come in a variety of forms, each with its own set of benefits and drawbacks.
Unlike stocks, most bonds aren't traded publicly, but rather trade over the counter, which means you must use a broker. Treasury bonds, however, are an exception -- you can buy those directly from the U.S. government without going through a middleman.
The problem with this system is that, because bond transactions don't occur in a centralized location, investors have a harder time knowing whether they're getting a fair price. A broker, for example, might sell a certain bond at a premium (meaning, above its face value). Thankfully, the Financial Industry Regulatory Authority (FINRA) regulates the bond market to some extent by posting transaction prices as that data becomes available.
Stocks are investments in a company's future success. When you invest in a company's stock, you profit along with them.
Learn about exchange-traded funds, or ETFs, which trade in a manner similar to stocks.
This popular investment vehicle tracks a market index and can help balance your portfolio.
Learn how bond investing can fit into the bigger picture of financially planning for your life.
The only person who can answer that question is you. Here are some scenarios to consider as you decide:
If you're the risk-averse type who truly can't bear the thought of losing money, bonds might be a more suitable investment for you than stocks.
If you're heavily invested in stocks, bonds are a good way to diversify your portfolio and protect yourself from market volatility.
If you're near retirement or already retired, you may not have the time to ride out stock market downturns, in which case bonds are a safer place for your money. In fact, most people are advised to shift away from stocks and into bonds as they get older, and it's not terrible advice, provided you don't make the mistake of dumping your stocks completely in retirement.
A municipal bond is a debt issued by a state or municipality to fund public works. Like other bonds, investors lend money to the issuer for a predetermined period of time. The issuer promises to pay the investor interest over the term of the bond (usually twice a year), and then return the principal back to the investor when the bond matures.
A Treasury bond is debt issued by the U.S. government to raise money. Technically speaking, every kind of debt issued by the federal government is a bond, but the U.S. Treasury defines the Treasury bond as the 30-year note. Generally considered the safest investment in the world, U.S. Treasury securities of all lengths provide a nearly guaranteed source of income and hold their value in just about every economic environment.
A corporate bond is a debt instrument issued by a business to raise money. Unlike a stock offering, with which investors buy a stake in the company itself, a bond is a loan with a fixed term and an interest yield that investors will earn. When it matures, or reaches the end of the term, the company repays the bond holder.
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