Hello there, meet the bond market. As an asset class, it’s not as complicated as you may think—and if you haven’t considered including bonds in your portfolio, it may be time to do so.
A bond is, in essence, a loan from an investor (you) to a borrower. “It’s different from a stock [a unit of ownership in a company] in that you’re legitimately lending the money to someone or something,” says Liz Young, head of investment strategy at SoFi, a personal finance company.
That borrower could be corporations (thereby issuing a corporate bond), the federal government (thereby issuing a U.S. treasury bond) or cities and states (thereby issuing a municipal bond). The money allows companies to finance projects, and cities, states and federal governments to build things like schools and roads.
The investor, on the other hand, receives a fixed rate of return over a set period of time: “You’re going to get the money back at maturity, and you’re also going to get interest payments along the way,” says Leslie Thompson, chief investment officer at Spectrum Wealth Management.
Sound appealing? Here’s what you need to know.
What Is the Bond Market?
The bond market is where bonds are bought and sold. It’s also sometimes called the debt market because “all bonds are some form of debt,” Young says.
The bond market has two different segments: the primary market and the secondary market. The primary market is where brand-new bonds are issued and bought directly (meaning they weren’t public beforehand) and the secondary market is where bonds go after they’ve been sold in the primary market and where investors can purchase them from brokers or other third parties.
The bond market can then be further broken down by bond classification—that is, the aforementioned corporate bond market, the government bond market and the municipal bond market.
Bonds are also organized by ratings that indicate the quality of the investment. For example: “The corporate bond market is organized by investment-grade bonds, which are high quality, and below-investment-grade bonds, also known as high yield or ‘junk,’” Young says. High-yield bonds have the highest payout but are also the riskiest, meaning there is a chance you won’t get your money back.
Why Should I Invest in Bonds?
There’s one simple reason why people invest in the bond market: It’s generally more stable than the stock market.
“Bonds tend to have a reputation for being safer investments because, traditionally, they have pretty low volatility,” says Lucas Bucl, chief investment officer at Aspyre Wealth Partners, a financial planning and career coaching firm. But, while their prices don’t fluctuate as much as stocks, their returns aren’t as high.
And, like everything else, they can be affected by rising interest rates. In 2022, for example, the price of highly rated bonds decreased because the Federal Reserve increased interest rates to fight inflation.
“This year has been a remarkably bad year in the bond market because bond prices move inverse or opposite of interest rates,” Bucl says. “As interest rates rise, bond prices fall.”
But that doesn’t mean you shouldn’t make bonds part of your portfolio: “The traditional diversified portfolio is a 60-40 allocation, meaning 60% stocks and 40% bonds,” Young says. “And there is no perfect time to invest.” Trying to time the ups and downs of the market usually doesn’t work.
If you’re worried about bonds you already own, Bucl says, the best move may be no move. “Don’t make any dramatic changes,” he adds.
How Do I Invest in Bonds?
You can buy bonds by going through a broker or directly through the U.S. Treasury’s website.
“In the past, individual investors mostly owned bonds through mutual funds,” Young says, which is a fund that pools together money and invests it in things like stocks and bonds.
Now more people are turning to exchange-traded funds (ETFs), which come at a lower cost than mutual funds, Young says. “There are quite a few bond ETFs out there, and a bond ETF is going to track a bond index.”
Young also suggests looking for higher-quality, versus higher-yield, bonds when you start out and sticking with treasuries and investment-grade corporate bonds.
Furthermore, you’ll want to determine how long you’d like to invest, especially if you’re buying bonds individually. “When you’re looking at bonds, you want to match the maturity of the bond to the timeframe of when you need the cash,” says Thompson. “If you’re saving up for a house or a big purchase in three years, look into buying shorter-term bonds.”
Liz Knueven is a freelance writer and certified personal finance educator. She contributes to U.S. News and World Report and her work has been published in various outlets, including Buzzfeed.
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