Individual Bonds

New to bonds?

Investors often overlook bonds because they're more familiar with stocks. To understand bonds, start by understanding how they differ from stocks.

What exactly is a bond?

Both stocks and bonds are issued as a way to raise money. The difference is this: When you purchase stock, you become one of the company's owners. When you invest in a bond, you are one of the company's lenders. So you can think of a bond as an IOU, because that's what it is–a promise to pay back the money you've loaned, with interest.

Primary differences between stocks and bonds

	Stocks	Bonds
Investment Objective	For growth and to outpace inflation.	For stability, diversification, and income.
Risk	Higher. Principal values can be volatile. In the case of bankruptcy liquidation, stockholders receive their payment after bondholders and other creditors.	Lower. Principal value is generally less volatile than stock prices. However, all bonds are susceptible to interest rate risk, credit risk, and default risk.
Income	Some pay quarterly and special dividends.	Most pay a fixed amount of income to holders each year.
Ownership	Ownership in the company. Depending on stock type, shareholders could have voting rights.	No ownership. Bondholders do not have voting rights.
Trading	Trade through a centralized exchange, which consists of competing buyers and sellers.	Most bonds trade over-the-counter (OTC)—that is, between bond dealers without the use of a centralized exchange.
Return of Principal	Stocks do not promise to return principal.	Most bonds promise to return principal on a stated maturity date.

 

How bonds are paid out.

$30,000 (Bond face value) x 5% (Bond interest (coupon) rate) = $1,500 (Annual interest payment - $750 Semiannual payments)

Helpful terms

Face value: A bond's face value is the amount the issuer is obligated to pay back when the bond matures. For most bonds, the face value is $1,000 and never changes.

Interest rate: Sometimes called the "coupon rate," this is the percentage of the bond's value the issuer agrees to pay the bondholder each year. Interest rates can be either fixed or variable, and most bonds pay interest twice a year.

Maturity date: This is the date on which the issuer has promised to pay back the face value of the bond. Maturities can range from a few weeks to 30 years or more. For some bonds, the issuer reserves the option to pay off the bond before the maturity date. These are referred to as "callable" bonds.

Primary market: This is where newly issued securities are sold. When you buy a new issue in the primary market, you pay the new-issue offering price, which is the same for all buyers.

Secondary market: This is where previously issued bonds are traded between dealers and investors, including institutions. Bond prices are allowed to float at prices set by the market.

Yield to maturity: This is the bond's expected annual rate of return if you hold it to maturity. It includes interest payments and reflects any gain or loss you may realize if you purchase.

Consider bond laddering to balance between income and risk.

A bond ladder is a portfolio of individual bonds with different maturity dates. The staggered maturity dates help reduce risk if interest rates fluctuate. And since many bonds generally pay out twice a year on dates that coincide with their maturity date, monthly bond income can be structured around those dates.

Learn More About How Bond Ladders Work

Who issues bonds?

While stocks are issued exclusively by companies, bonds are issued by both public and private entities. Cities, states, the federal government, government agencies, and corporations issue bonds to raise capital for a variety of purposes, such as building roads, improving schools, opening new factories, and buying the latest technology.

How do bond rates and yields work?

The return (yield) you're quoted when you buy a bond is often different from the interest it pays. Why? Because in addition to the annual interest rate, the bond's return reflects any difference between its purchase price and its face value—the amount you're expected to receive when the bond matures.

• If you buy the bond at a price higher than the face value (at a premium), you'll receive less than you paid when the bond matures.
• If you buy the bond at a price lower than the face value (at a discount), you'll receive more than you paid.
• If you sell the bond before it matures, you get its current price, which may be higher or lower than the amount you originally paid.