Investing in bonds
When you're investing in bonds, you're essentially loaning money to an entity — this could be a government, a city, or a corporation. In return, they promise to pay you back the full amount of the loan at a certain date in the future, known as the maturity date, and to make regular interest payments to you until that time.
Imagine you're investing in a bond from a well-established corporation, let's say Microsoft, that wants to raise money for a new project. They issue a bond with a face value of $1,000, a maturity date in 10 years, and an annual interest rate, also known as a coupon rate, of 3%.
In this scenario, you would pay $1,000 to buy the bond. Every year, Microsoft would then pay you 3% of the face value — so $30 — as interest. These payments would continue for 10 years. At the end of the 10 years, Microsoft would return your original $1,000 investment. So, over the decade, you would have earned $300 in interest, and you get your initial $1,000 back.
Investing in bonds can be a lower-risk option than stocks, as you're guaranteed to get your initial investment back if you hold the bond until maturity and the issuer doesn't default. However, the returns can be lower than those for stocks. Also, bonds can decrease in value if interest rates rise, but you won't lose your initial investment if you hold the bond until maturity.
It's also important to consider the creditworthiness of the entity issuing the bond. Government bonds are generally considered safe as they're backed by the taxing power of the country, while corporate bonds have varying levels of risk depending on the stability and profitability of the company.