What bonds are and how they work: stocks or bonds
A bond is an IOU. You lend money to a government or a company, and they pay you interest and return the whole sum on a set day.
- A bond is a loan: you are paid interest and get the whole sum back at the end.
- When rates rise, the price of existing bonds falls.
- Stocks are for growth over years, bonds for preserving and smoothing declines; usually you need both.
How it works
A bond has three main numbers:
- Face value — the sum returned at the end. Usually 1,000.
- Coupon — the interest paid along the way. A 5% coupon on 1,000 is 50 a year.
- Maturity — when the face value comes back: in one, five or thirty years.
You buy a bond, collect coupons and get the face value at maturity. If the borrower has not gone bust, the outcome is known in advance. That is the main difference from a stock.
Why a bond's price changes
Bonds trade on exchanges and their price differs every day. The main rule:
The longer the maturity, the more the price reacts to rates. In 2022, when rates jumped, bond funds lost more than a tenth of their value — a lot for a “calm” asset.
If you hold a bond to maturity, price swings do not matter: the face value is returned in full.
What kinds exist
| Kind | Who owes | Income and risk |
|---|---|---|
| Government | The state | The safest, lower income |
| Corporate | Large companies | Higher income, company risk |
| High-yield | Weak companies | A high coupon, a real risk of non-payment |
| Inflation-protected | The state | Face value rises with prices |
What the holder risks
- The borrower does not pay. The higher the promised rate, the higher this risk.
- Rates rise — and the price falls if you need to sell early.
- Inflation eats fixed income: 4% with prices rising 6% is a loss.
Stocks or bonds
| Stocks | Bonds | |
|---|---|---|
| What it is | A piece of a business | A debt owed to you |
| Income | Unknown in advance, higher over the long run | Known in advance, lower |
| Swings | Strong, declines of 30–50% | Moderate |
| What for | Growing capital over 10+ years | Preserving it and smoothing declines |
The right answer is almost always “both”. The shorter the time to your goal and the worse you handle declines, the larger the bond share. Saving for twenty years — stocks form the core. Money needed in three years — bonds form the core.
The simplest way to buy
Individual bonds are hard to choose. It is easier to take a bond fund: it holds hundreds or thousands at once, and one default barely shows. Examples are BND and AGG; you can open the holdings of each on the site.
Work out the shares of stocks and bonds for your goal and age.
Split →A short course: bonds and funds step by step, with questions.
Course “Bonds and funds” →This article is educational and is not investment advice. Bonds do not guarantee income: the borrower may fail to repay.