What Are Bonds, Anyway?

Let’s be honest. Nobody’s sitting around a backyard barbecue saying “Hey, wanna hear about my bond portfolio?”

Bonds aren’t flashy. They don’t make headlines like stocks. Nobody brags about them on social media.

But bonds have been a mainstay of investing for a very long time, and they can play an important role in an investment journey.

What is a bond?

A bond is basically an IOU.

That’s it. You lend money to a government or company, and they agree to pay you interest in exchange for borrowing your money. Then, at some point in the future, they pay you back.

Think of it this way: when you take out a car loan, the bank is lending money to you. When you buy a bond, you’re acting like the bank.

A bond is simply a loan where you’re lending the money instead of borrowing it.

Why would anyone buy bonds?

Good question. After all, stocks tend to get all the attention.

Many investors buy bonds because they generally offer more stability than stocks and are lower risk than many other investments.

Bonds also pay interest to you during the life of the bonds, which is their way of saying “thank you for lending me the money”. And if everything works out okay, you receive your principal (i.e. the amount you invested) back when the bond is done.

In other words, bonds are often less exciting than stocks. And that’s kind of the point.

U.S. Treasury Bonds

Treasury bonds are issued by the U.S. government. When you buy one, you’re lending money to Uncle Sam. In return, the government pays you interest.

These are typically considered some of the safest investments in the world. If the U.S. government can’t pay its debts, we’ve probably got bigger problems than the investments we own.

I-Bonds

I-Bonds are a special type of U.S. savings bond.

What’s unique about them is that their interest rate is tied to inflation (which is the rate that the price of stuff we pay for or buy increases over time).

If groceries, gas, and rent are all getting more expensive, inflation is probably running high.

I-Bonds adjust their interest rate to keep up. That’s why they’re incredibly popular when inflation spikes. At one point in 2022, I-Bonds were paying interest rates above 9%.

Pretty wild for investments that people refer to as “vanilla”.

There are a few catches to I-bonds, though. You can only buy a limited amount each year and your money is locked up for at least 12 months. In addition, rates change over time as inflation changes.

Municipal Bonds

Municipal bonds, often called “munis,” are issued by state and local governments. Cities, counties, and school districts use them to help fund things like:

• Schools
• Roads
• Bridges
• Public construction or infrastructure projects

One reason investors like municipal bonds is that they often come with tax advantages (like paying no federal tax on the interest). The details can get a little complicated, but the tax benefits are one reason many investors pay attention to them.

Corporate Bonds

Corporate bonds are issued by companies. Instead of lending money to the government, you’re lending money to a business.

Companies issue bonds to raise money for things like hiring new people, creating new projects, or just general day-to-day company operations.

Corporate bonds often pay higher interest rates than government bonds.

Why? Because they’re usually riskier. A company is more likely to run into financial trouble than the U.S. government.

Bond Funds and Bond ETFs

Most investors don’t actually buy individual bonds. Instead, they buy bond funds or bond ETFs.

A bond ETF might own hundreds or even thousands of bonds. That can make diversification easier and reduce the risk of any single bond causing problems.

Are bonds exciting?

Not really. And that’s okay.

Bonds are often the vegetables of investing… not the most exciting thing on the plate, but they can still be good for you.

Why it matters

At Firreo, we focus more on investments that can grow over time and provide meaningful income to you. But that doesn’t mean bonds don’t have a place in the investment world.

For some investors, bonds can provide stability, income, and peace of mind during times when stock markets are acting crazy.

Like most investments, bonds aren’t perfect. They’re just another tool in the financial toolbox.