If stocks represent ownership, bonds represent debt.
That one distinction explains most of the difference between the two.
When you buy a stock, you become a shareholder in a company.
When you buy a bond, you are generally lending money to whoever issued it.
That borrower might be a government trying to finance public spending, a city building infrastructure or a company raising money for a new factory.
In return, the borrower promises to repay the money according to the bond's terms.
Many bonds also pay interest while you wait.
The basic deal is simple.
You lend money now. The borrower pays you for using it and promises to return the principal later.
The complicated part begins when bonds start trading.
A bond can have one interest rate written into its terms while investors in the market earn a completely different yield.
Its price can rise.
Its price can fall.
Interest rates can change what investors are willing to pay for it.
A bond that originally cost $1,000 might later trade for $950 or $1,050 even though its contractual payments have not changed.
Understanding why that happens is the key to understanding the bond market.
What is a bond?
A bond is a debt security.
It is essentially a formal IOU that can be bought and sold.
The organization borrowing the money is called the issuer.
The investor who owns the bond is the bondholder.
The issuer agrees to follow specific terms.
Those terms can include:
How much money will eventually be repaid.
When repayment will happen.
How much interest will be paid.
How often interest will be paid.
Whether the issuer can repay the bond early.
Whether the interest rate is fixed or variable.
Not every bond has exactly the same structure.
But most begin with the same economic relationship:
The investor is lending money rather than buying part of the issuer.
Suppose a company issues a $1,000 bond with a 5% annual coupon and a maturity of ten years.
An investor buys it.
The company now has the investor's money.
If the bond pays interest every six months, the investor may receive $25 twice a year.
At the end of ten years, assuming the company meets its obligations, the investor receives the $1,000 principal back.
That is the basic bond.
Everything else comes from changing the terms or changing the price investors are willing to pay for those promised cash flows.
How does a bond work?
A bond has a life cycle.
First, the borrower decides it needs money.
A government may need to finance spending.
A company may want to build a factory.
A municipality may want to construct a hospital.
Instead of obtaining all the money through a bank loan, the borrower can issue bonds to investors.
The bond spells out what investors are promised.
Suppose a company wants to borrow $100 million.
It could issue 100,000 bonds with a face value of $1,000 each.
If every bond is sold, the company has raised $100 million before considering issuance costs.
The company may promise to pay a fixed amount of interest each year.
Eventually, each bond reaches its maturity date.
At maturity, the issuer generally repays the bond's face value.
The borrowing relationship then ends.
But investors do not necessarily need to keep the bond until that date.
Many bonds can be sold to another investor before maturity.
That secondary trading creates something that initially seems strange:
The amount the bond promises to pay can stay the same while the market price of the bond changes every day.
Why do governments and companies issue bonds?
Bonds let organizations borrow large amounts of money from investors.
A government may issue debt to finance budget needs or public projects.
A company may borrow to:
Expand operations.
Purchase equipment.
Build facilities.
Acquire another company.
Refinance existing debt.
Fund research.
Or handle other corporate expenses.
Cities and other public authorities can issue debt to finance infrastructure such as roads, water systems, schools and hospitals.
The attraction for the borrower is access to capital.
The attraction for investors is the possibility of earning income and receiving their principal back later.
Of course, borrowing creates an obligation.
The issuer must meet the bond's payment terms.
If it cannot, the borrower may default.
That is why investors care so much about the financial strength of whoever issued the bond.
What is the difference between a bond and a loan?
A bond is a type of borrowing, so economically it shares a lot with an ordinary loan.
The borrower receives money.
The lender expects repayment.
Interest may be charged.
But bonds are securities.
They can often be divided among many investors and traded in financial markets.
Imagine a company needs $500 million.
One bank could theoretically provide a huge loan.
Or the company could issue bonds that thousands of investors and institutions purchase.
Those bonds may later trade between investors without the company needing to negotiate a completely new loan every time ownership changes.
This marketability is one of the defining features of many bonds.
Who issues bonds?
Many different organizations can issue debt securities.
National governments
Governments borrow to finance spending and manage public finances.
The bonds of large sovereign governments form some of the world's most important financial markets.
Companies
Corporations issue corporate bonds.
The risk depends partly on the company's ability to continue making promised payments.
States and municipalities
Regional and local governments can issue debt to finance public projects.
In the United States, these securities are commonly called municipal bonds.
Government agencies and other organizations
Various government-linked entities, financial institutions and other organizations can also issue debt.
Different issuers carry different risks.
Lending to a financially strong national government is not the same as lending to a heavily indebted company whose business is struggling.
That difference affects the interest rate investors demand.
What are principal, face value and par value?
Three terms appear constantly in bond investing:
Principal. Face value. Par value.
They often refer to the amount the issuer promises to repay when the bond matures.
Suppose a bond has a face value of $1,000.
At maturity, assuming no default and no unusual terms, the investor receives $1,000.
But that does not mean the bond always costs $1,000 in the market.
Before maturity, investors might buy and sell it for:
$920.
$1,000.
$1,080.
Or another price.
Its face value can stay at $1,000 while its market price moves around.
This is one of the most important distinctions in bond investing.
What is a bond's maturity?
A bond's maturity date is the date when its principal is scheduled to be repaid.
Some debt matures quickly.
Other bonds can remain outstanding for decades.
Maturity matters because lending money for a long period usually creates more uncertainty.
Inflation may change.
Interest rates may rise or fall.
The issuer's financial situation may deteriorate.
Better investment opportunities may appear.
This is one reason longer-term bonds can behave differently from short-term bonds.
A bond with six months left before maturity is not exposed to the same amount of interest-rate uncertainty as a similar bond with 30 years remaining.
Maturity therefore affects both return and risk.
What is a coupon?
A bond's coupon is its interest payment.
The name comes from an earlier era when physical bond certificates sometimes had coupons that investors literally detached and presented for payment.
Modern bond ownership is generally electronic, but the name survived.
Suppose a bond has:
Face value: $1,000
Coupon rate: 6%
The annual coupon is:
$1,000 × 6% = $60
If it pays interest twice a year, the investor would generally receive two payments of $30.
The important part is that the coupon is based on the bond's face value, not necessarily the price someone later pays for it.
That distinction creates the difference between a bond's coupon rate and its yield.
Coupon rate vs interest rate
In ordinary conversation, people may describe a bond's coupon rate as its interest rate.
For a fixed-rate bond, the coupon rate is established when the security is issued.
Suppose a $1,000 bond has a 5% coupon.
It pays $50 a year.
If the bond later trades for $900, it does not suddenly start paying 5% of $900.
The contractual $50 annual payment can remain the same.
If it trades for $1,100, the coupon can still remain $50.
The payment stays fixed.
What changes is the return that payment represents relative to the price an investor actually pays.
That return is where yield enters the picture.
What is bond yield?
A bond's yield describes the return an investor receives relative to its price or expected cash flows.
This is where bonds begin to look confusing because there is more than one type of yield.
You may encounter:
Current yield.
Yield to maturity.
Yield to call.
Yield to worst.
The most important beginner lesson is this:
Coupon and yield are not automatically the same number.
The coupon tells you what the bond contract pays based on face value.
Yield tells you more about what that investment is offering at its current market price.
Coupon rate vs yield
Imagine a $1,000 bond pays $50 every year.
Its coupon rate is 5%.
Now suppose interest rates rise elsewhere and investors will only buy that old bond for $900.
The bond still pays $50 annually.
But someone paying only $900 is receiving that $50 payment on a smaller investment.
The return relative to the purchase price is therefore higher than 5%.
Now imagine the opposite.
The bond becomes attractive and investors bid its price up to $1,100.
It still pays $50.
But someone paying $1,100 is receiving the same $50 annual payment on a larger investment.
Their yield is lower.
This is why the same bond can have:
One fixed coupon rate but changing yields.
What is current yield?
Current yield compares a bond's annual coupon payment with its current market price.
The rough formula is:
Current yield = annual coupon payment ÷ market price
Suppose a bond pays $60 a year.
Its market price is $1,000.
Current yield:
$60 ÷ $1,000 = 6%
Now suppose its price falls to $900.
The bond still pays $60.
Current yield becomes:
$60 ÷ $900 = about 6.67%
If its price rises to $1,100:
$60 ÷ $1,100 = about 5.45%
This demonstrates the fundamental bond relationship:
Price down → yield up.
Price up → yield down.
But current yield does not tell the whole story because it ignores the gain or loss that may occur when the bond eventually returns to its face value at maturity.
For that, investors often look at yield to maturity.
What is yield to maturity?
Yield to maturity, or YTM, estimates the annualized return an investor would receive if they purchase a bond at its current price and hold it until maturity, assuming the bond makes its promised payments and using standard assumptions about the cash flows.
YTM considers more than the coupon.
It incorporates:
The purchase price.
Coupon payments.
Time remaining.
The amount repaid at maturity.
Suppose a $1,000 face-value bond is available for $900.
The investor can receive coupon payments and, if the issuer performs as promised, eventually receive $1,000 at maturity.
That $100 difference contributes to the investor's return.
Now consider a $1,000 bond bought for $1,100.
At maturity, only $1,000 may be returned.
The investor effectively loses $100 of the purchase premium by maturity.
That reduces the return.
Yield to maturity is therefore usually more informative than simply looking at the coupon rate.
Why do bond prices change?
Once a bond begins trading in the secondary market, investors decide what its remaining cash flows are worth.
That judgment changes constantly.
Several things can move a bond's price:
Interest rates.
Inflation expectations.
The issuer's creditworthiness.
Time remaining until maturity.
Market liquidity.
Economic conditions.
Demand for safer assets.
Currency conditions.
Changes in the bond's rating.
And expectations about future rates.
The most important relationship for beginners is between bond prices and market interest rates.
For existing fixed-rate bonds, they generally move in opposite directions.
Why do bond prices fall when interest rates rise?
Suppose you own a bond with:
Face value: $1,000
Coupon: 3%
Annual interest: $30
Now imagine newly issued comparable bonds begin offering 5%.
Why would an investor pay you $1,000 for a bond that pays $30 annually when a new $1,000 bond can pay $50?
Your old bond has become less attractive.
If you want to sell it, you may need to reduce its price.
At a sufficiently lower price, its fixed $30 payment becomes more competitive with newer bonds.
This creates the famous bond-market rule:
Interest rates rise → existing fixed-rate bond prices generally fall.
The bond itself did not necessarily become defective.
The alternatives simply became better.
Why do bond prices rise when interest rates fall?
Now reverse the example.
You own a $1,000 bond paying 5%.
New comparable bonds are being issued at only 3%.
Your old bond's $50 annual coupon suddenly looks attractive beside the new bond's $30.
Other investors may therefore be willing to pay more than $1,000 to obtain your higher coupon.
The price rises.
As that price rises, the return available to a new buyer falls.
So:
Interest rates fall → existing fixed-rate bond prices generally rise.
This inverse relationship between price and yield sits at the center of the bond market.
What does it mean when a bond trades at par, a premium or a discount?
A bond can trade at three broad price levels relative to face value.
At par
If a $1,000 bond trades for $1,000, it is trading at par.
At a premium
If the same bond trades for $1,080, it trades at a premium.
The investor pays more than the amount scheduled to be returned at maturity.
This can happen when the bond's coupon is attractive relative to current market rates.
At a discount
If it trades for $920, it trades at a discount.
The investor pays less than face value.
This may happen when its coupon is lower than rates available on comparable new bonds.
Credit concerns can also cause large discounts.
A bond trading far below face value may not simply be offering a wonderful bargain.
The market may believe there is a serious risk that the issuer will not make all of its promised payments.
What happens if you hold a bond until maturity?
Suppose you buy a conventional $1,000 bond and hold it until maturity.
If the issuer fulfills the contract, you receive the promised interest payments and eventually the $1,000 face value.
During those years, the bond's market price may rise or fall.
If you do not sell it, those temporary market-price changes do not necessarily change the contractual amount the issuer owes you at maturity.
This is why an individual bond held to maturity can behave differently from one that an investor expects to sell early.
However, holding to maturity does not eliminate every risk.
The issuer could default.
Inflation could reduce the purchasing power of the payments.
A callable bond may be redeemed early.
And the investor could miss better opportunities elsewhere.
“Matures at $1,000” should never be confused with “cannot lose money under any circumstances.”
Can you sell a bond before maturity?
Often, yes.
Many bonds trade in the secondary market.
If you sell before maturity, however, you receive the market price rather than automatically receiving face value.
Suppose you paid $1,000 for a bond.
Rates rise.
Its market value falls to $900.
If you need to sell immediately, you may have to accept around $900.
You have realized a loss.
If rates instead fall and the bond becomes worth $1,100, selling could generate a gain.
Liquidity also matters.
Some bonds trade frequently.
Others trade much less often.
Finding a buyer for an obscure bond may be harder, and the difference between the price buyers offer and sellers request can be wider.
A bond may therefore promise a fixed payment at maturity without having a fixed resale price today.
What are government bonds?
A government bond is debt issued by a government.
National governments borrow for many reasons, including financing spending and managing public finances.
Government debt can be viewed as relatively safe or extremely risky depending on:
The country.
The currency.
The government's finances.
Inflation.
Political stability.
And the government's ability and willingness to repay.
There is therefore no universal rule that says:
Government bond = risk-free.
Investors often treat debt issued in the government's own currency by financially strong sovereigns as having relatively low default risk.
But governments can default, restructure debt or repay investors with money whose purchasing power has fallen badly.
The details matter.
What are Treasury bills, notes and bonds?
The United States finances part of its borrowing through Treasury securities.
The names can be confusing because “bond” is also the general word for debt securities.
In the U.S. Treasury market:
Treasury bills are short-term securities.
Treasury notes cover intermediate maturities.
Treasury bonds are longer-term securities.
Bills are generally sold at a discount or at par and repay face value at maturity rather than paying conventional coupon interest along the way.
Treasury notes and bonds generally pay interest periodically.
There are also:
Treasury Inflation-Protected Securities, or TIPS.
Floating Rate Notes, or FRNs.
These are different structures designed to expose investors to different types of interest-rate and inflation behavior.
Treasuries play an enormous role in global finance because their yields help serve as reference points for pricing many other assets.
What are corporate bonds?
A corporate bond is debt issued by a company.
Instead of selling additional ownership through stock, a company borrows from bond investors.
The company agrees to pay according to the bond's terms.
Corporate bonds can vary dramatically in risk.
A profitable company with modest debt may borrow at relatively low rates.
A struggling company with heavy debt may need to offer investors far higher yields.
Why?
Because investors want compensation for taking a greater chance that payments will not be made.
Unlike a common shareholder, a bondholder does not normally participate directly in unlimited upside if the company becomes spectacularly successful.
If you own a bond promising 5%, the company doubling its profits does not automatically increase your coupon to 20%.
The trade-off is priority.
Creditors generally have claims ahead of common shareholders if the company fails.
What are municipal bonds?
Municipal bonds, often called munis, are debt securities issued by states, cities, counties and other government entities, particularly in the United States.
The money may finance projects such as:
Schools.
Roads.
Water systems.
Hospitals.
Public transportation.
Or other infrastructure.
Some municipal bonds are backed by broad taxing authority.
Others are connected to revenue from particular projects or systems.
Their risks therefore vary.
Municipal bonds can also receive favorable tax treatment for some U.S. investors.
That does not mean every muni is automatically safe or appropriate for every investor.
The issuer's finances and the bond's exact structure still matter.
What are investment-grade and high-yield bonds?
Corporate and other bonds are often grouped by their credit quality.
Investment-grade bonds
These receive ratings considered relatively stronger by major credit-rating agencies.
The market generally views them as carrying lower default risk than speculative bonds.
Lower perceived risk often means the issuer can borrow more cheaply.
High-yield bonds
These have lower credit ratings.
They are also called non-investment-grade, speculative-grade or sometimes junk bonds.
The less flattering name explains the trade-off.
The issuer must usually offer a higher yield because investors are accepting greater credit risk.
Higher yield is not free extra income.
It is often the market's compensation for greater danger.
If one bond yields 4% and another comparable-looking bond yields 12%, the immediate question should not be:
“Why would anyone buy the 4% bond?”
It should be:
“Why does the market demand 12% from the other borrower?”
There is usually a reason.
What are zero-coupon bonds?
A zero-coupon bond does not make ordinary periodic coupon payments.
Instead, the investor typically buys it below face value and receives the face value at maturity.
Imagine paying $700 today for a bond that will pay $1,000 years later.
The $300 difference represents the investor's return, assuming the issuer pays as promised.
Zero-coupon bonds can be especially sensitive to changing interest rates because investors receive no periodic coupon cash flows before maturity.
Their tax treatment can also be unusual in some jurisdictions because investors may owe tax on interest that has economically accrued even before cash is actually received.
The rules depend on the country and account type.
What are floating-rate bonds?
Not every bond pays a permanently fixed coupon.
A floating-rate bond has an interest rate that resets based on a benchmark or formula.
For example, the coupon might equal:
Reference rate + 1.5 percentage points
If the reference rate rises, the bond's payment can rise.
If the reference rate falls, the payment can fall.
Floating-rate securities therefore react differently to rate changes than traditional fixed-rate bonds.
They generally carry less sensitivity to rising interest rates because the coupon itself adjusts.
But they can still have:
Credit risk.
Liquidity risk.
Benchmark risk.
And other risks.
“Floating rate” does not mean “safe.”
It simply describes how the interest payment is determined.
What are inflation-linked bonds?
Inflation can be painful for bond investors.
Imagine locking in a fixed payment of $50 a year.
If prices double over time, that $50 buys much less.
Inflation-linked bonds are designed to provide some protection against that problem.
A well-known example is the U.S. Treasury Inflation-Protected Security, or TIPS.
With TIPS, the principal adjusts with a measure of consumer prices.
The fixed interest rate is then applied to the adjusted principal.
As inflation raises the principal, the dollar amount of interest can rise as well.
Inflation-linked bonds do not remove every possible risk.
Their market prices can still fluctuate.
Real interest rates can change.
And different countries use different inflation measures and structures.
But they provide a way to link part of the bond's value more directly to inflation.
What are callable bonds?
Some bonds have a feature that benefits the issuer.
They are callable.
A callable bond allows the borrower to repay the debt before its scheduled maturity under specified conditions.
Imagine a company issued bonds years ago at 8%.
Market rates later fall to 4%.
The company would love to stop paying 8%.
If the bonds are callable, it may be able to repay investors early and refinance at a cheaper rate.
That sounds great for the issuer.
It may be frustrating for the investor.
The investor loses a high-yielding bond exactly when comparable new investments are offering lower rates.
That is called call risk.
Callable bonds may therefore need to offer investors more attractive terms to compensate for that possibility.
What are bond credit ratings?
Credit-rating agencies issue opinions about an issuer's ability to meet its debt obligations.
These ratings help investors compare credit risk.
Higher ratings generally suggest lower perceived default risk.
Lower ratings suggest greater risk.
Ratings can influence borrowing costs.
A company with strong credit may be able to issue debt at a relatively low yield.
A company viewed as risky may need to pay significantly more.
But ratings are not guarantees.
Agencies can be wrong.
A borrower's finances can deteriorate.
Ratings can be downgraded.
Investors should therefore treat credit ratings as one piece of information rather than an automatic instruction to buy or sell.
What is default risk?
Default risk, or credit risk, is the possibility that the bond issuer fails to make promised payments.
That could mean:
Missing an interest payment.
Failing to repay principal.
Restructuring the debt.
Or otherwise violating the payment terms.
This is one reason riskier bonds usually offer higher yields.
Suppose Investor A can lend to a financially strong government at 4%.
Why would the same investor lend to a struggling company at 4%?
They probably would not.
The company needs to offer more compensation.
If the market believes default is increasingly likely, the bond's price may collapse and its yield can surge.
A very high yield can therefore be a warning sign rather than a gift.
What is interest-rate risk?
Interest-rate risk is the risk that changing market rates alter the value of an existing bond.
Fixed-rate bonds are especially easy to understand.
If new bonds offer better rates, old lower-paying bonds become less valuable.
If new bonds offer worse rates, old higher-paying bonds become more valuable.
Interest-rate risk matters most when an investor may need to sell before maturity.
The longer the bond has left to run, the more sensitive it can be to rate changes.
This leads to a concept called duration.
What is duration?
Duration is a measure used to estimate how sensitive a bond's price is to changes in interest rates.
It is expressed in years, but it should not be confused with maturity.
A simplified interpretation is:
The higher the duration, the more sensitive the bond's price tends to be when interest rates change.
Suppose a bond fund has a duration of approximately seven years.
A one-percentage-point increase in interest rates might correspond to roughly a 7% decline in price, all else equal.
That is an approximation, not a guarantee.
Real bond pricing is more complicated.
Duration changes as rates, time and cash flows change.
But the concept is extremely useful.
It explains why long-term bonds can move dramatically even when nobody believes the issuer is about to default.
Their value is highly sensitive to the discount rate applied to cash flows far in the future.
What is inflation risk?
Imagine buying a bond paying 4%.
Inflation then runs at 7%.
You are still receiving the promised nominal payment.
But your money is losing purchasing power faster than the bond is generating income.
This is inflation risk.
Fixed payments are especially vulnerable because their dollar amount does not automatically rise with the cost of living.
This is why investors care about real yields.
A rough real-return calculation is:
Nominal yield − inflation
If the bond yields 5% and inflation is 2%, the rough real yield is positive.
If the bond yields 3% while inflation is 6%, purchasing power is falling despite receiving interest.
The actual calculation can be more complex, but the principle is straightforward:
What matters is not only how many currency units you receive but what those units can buy.
What is liquidity risk?
A bond can be valuable on paper but difficult to sell at the price you expect.
That is liquidity risk.
Some government bonds trade constantly in enormous markets.
Other securities may rarely change hands.
If few investors are willing to buy a particular bond, a seller may need to accept a lower price.
The bid-ask spread may also be wide.
Liquidity becomes especially important during financial stress.
A market that seems liquid during calm conditions can suddenly become much harder to trade when investors rush to sell.
This is another reason two bonds with similar contractual payments may offer different yields.
Investors can demand compensation for owning something that may be difficult to sell.
What is reinvestment risk?
Suppose you own a bond paying 8%.
It matures.
Now the best comparable bonds available yield only 4%.
You receive your money back, but you cannot reinvest it at the old rate.
That is reinvestment risk.
Callable bonds can make this especially frustrating.
If rates fall, the issuer may call an expensive bond early.
The investor suddenly receives their money back at exactly the moment when replacement bonds pay less.
Reinvestment risk also applies to coupon payments.
A yield calculation may assume that interest received along the way can be reinvested at certain rates.
Reality may be different.
What is a yield curve?
A yield curve compares bond yields across different maturities.
Imagine plotting:
Three-month yield.
Two-year yield.
Five-year yield.
Ten-year yield.
Thirty-year yield.
On the same chart.
The line connecting them is a yield curve.
To make the comparison meaningful, investors typically look at securities with similar credit quality, such as government debt from the same issuer.
The shape of the curve tells investors how compensation changes as they lend for longer periods.
Why does the yield curve matter?
A normal yield curve often slopes upward.
Longer-term bonds offer higher yields than shorter-term bonds because investors accept more uncertainty by locking money up for longer.
But the curve can change shape.
Sometimes it becomes very flat.
Sometimes shorter-term yields rise above longer-term yields.
That is called an inverted yield curve.
An inversion can occur when investors expect future interest rates and economic growth to weaken.
Yield curves are therefore watched closely by:
Bond traders.
Economists.
Banks.
Central banks.
Investors.
And businesses.
But a yield curve is not a crystal ball.
An inversion does not tell you the exact date of a future recession.
It reflects the market's pricing of interest rates, risk and expectations at that moment.
Bonds vs stocks
Stocks and bonds fund companies in fundamentally different ways.
A stock investor is an owner
Buying common stock means purchasing equity.
If the company becomes vastly more valuable, shareholders can enjoy large upside.
There is no predetermined maximum stock price.
But shareholders also absorb substantial risk.
A bond investor is a lender
Buying a corporate bond means lending money to the company.
The upside is usually more limited.
If a company becomes ten times more profitable, its bondholders do not automatically receive ten times their interest.
They still receive whatever the bond contract promises.
But bondholders generally have a stronger legal claim on the company's payments than common shareholders.
If the company goes bankrupt, creditors usually stand ahead of shareholders.
This trade-off explains why stocks and bonds often play different roles in portfolios.
Stocks are commonly used for growth.
Bonds are often used for income, capital preservation and diversification.
Neither is automatically safe.
Neither is automatically better.
They solve different financial problems.
Individual bonds vs bond funds
Buying one bond is different from buying a bond fund.
Individual bond
An individual bond has specific contractual terms.
You can know its:
Face value.
Coupon.
Maturity.
Issuer.
And other conditions.
If you hold a conventional bond until maturity and the issuer pays as promised, you know what principal is scheduled to come back.
Bond fund
A bond fund pools investors' money and owns many bonds.
The portfolio may continuously buy and sell securities.
Most ordinary bond funds do not have one single maturity date on which an investor's original principal is promised back.
Their share prices fluctuate with the value of the bonds they own.
That distinction matters.
Someone might say:
“Bonds return principal at maturity.”
That can describe an individual bond.
It does not mean a bond fund is guaranteed to return your original investment on a particular date.
What is a bond ETF?
A bond ETF is an exchange-traded fund that holds bonds or other fixed-income securities.
Investors buy and sell shares of the ETF on an exchange much like stocks.
A bond ETF might hold:
Government bonds.
Corporate bonds.
Short-term debt.
Long-term debt.
High-yield bonds.
Inflation-linked bonds.
Or a broad mixture.
The ETF makes diversification easier because one share can provide exposure to many securities.
But a bond ETF still has risks.
Its market value can fall when interest rates rise.
Its holdings can suffer credit problems.
Its distributions can change.
And unlike a single traditional bond held to maturity, the fund itself may continue operating indefinitely.
The words bond fund should therefore never be interpreted as guaranteed principal.
How do investors make money from bonds?
Bond investors can earn returns in several ways.
Interest payments
Many bonds pay periodic coupons.
These create an income stream.
Buying below face value
An investor may buy a bond for $900 and receive $1,000 at maturity, assuming the issuer pays as promised.
That difference contributes to the return.
Selling at a higher price
A bond purchased for $1,000 might later trade for $1,100 because interest rates fell or the issuer's credit quality improved.
Selling can generate a capital gain.
Inflation adjustments
Certain inflation-linked securities can increase their principal as inflation rises.
But bonds can produce losses through the reverse of these same mechanisms.
Prices can fall.
Issuers can default.
Inflation can erode purchasing power.
Taxes and trading costs can reduce returns.
The number printed beside “coupon” therefore never tells the entire investment story.
Can you lose money on bonds?
Yes.
Calling bonds fixed income does not mean their prices are fixed.
You can lose money because:
Interest rates rise.
You sell before maturity at a lower price.
The issuer defaults.
Inflation erodes the value of payments.
The bond is called early.
Liquidity disappears.
Foreign exchange rates move against you.
Or a bond fund falls in value.
Even high-quality government bonds can lose market value when rates rise.
The thing that may be fixed is the bond's contractual payment structure.
The market value of those payments is not fixed.
That distinction is crucial.
Why do investors own bonds?
If bonds can lose money and stocks can offer greater upside, why buy bonds at all?
Because return is not the only objective in investing.
Some investors want income.
Others want less volatility than they expect from stocks.
Some need money at a particular future date.
Pension funds and insurance companies may use bonds to help match long-term obligations.
Banks hold enormous amounts of debt securities as part of their financial operations.
Investors may also use government bonds as defensive assets during periods of uncertainty.
A diversified portfolio can combine stocks and bonds because the two respond differently to economic conditions.
There is no universal percentage of bonds that everybody should own.
A 25-year-old saving for retirement has different needs from an 80-year-old who depends on portfolio income.
A bank has different needs from either person.
The point of bonds is not that they are boring stocks with smaller returns.
They are a fundamentally different contract.
Stocks let investors own part of a business. Bonds let investors become lenders.
Once that distinction is clear, the enormous global bond market becomes much easier to understand.