What is a bond?

Along with stocks, ETFs, and other types of investments, bonds are a cornerstone of many portfolios. For some investors, bonds offer the opportunity to diversify, earn steady income, and add stability to investments, especially in times of high volatility.

A bond is a fixed-income security that is a type of loan where you lend money to an issuer for a limited period, in exchange for receiving regular interest payments until the loan’s maturity date.  

Bonds are typically issued by federal, state, or local governments, and corporations to either raise money to fund government projects or to fulfill business needs. As an issuer, an entity may borrow hundreds of millions of dollars at a time, so the principal is divided into units that is usually in the amount of $1,000 each.

There are multiple types of bonds that can potentially complement your investing strategies, and help you reach your financial goals while still being relatively low risk.

Here are some key terms to know before you begin researching bond investments:

1. An issuer: The entity that borrows the money by issuing the bond. An issuer could be the United States government, a state or municipality, or a corporation.
2. Principal: The face value of the bond. It is the amount of money that the issuer is borrowing.
3. Maturity date: The due date when the issuer must repay the principal loan amount and any remaining interest to the bondholder. Once a bond is issued, its maturity date can range from a few months to over 30 years.
4. Interest rate, also called coupon rate: The fixed amount the issuer pays for borrowing the money. The interest rate is usually determined at the time the bond is issued, and most interest payments are distributed semiannually with the principal repaid at maturity, along with the final interest payment. The rate of interest you earn on your bond depends on the price you pay for the bond when you buy it.

The yield represents an investor’s return on the bond, conveyed as an annual percentage. 

Important yield terms:

When investing in bonds, you have the option to either keep them until maturity or trade them on the secondary market.

• Holding bonds: Bondholders who hold on to their bonds until the maturity date can expect steady income and their principal investment back once the loan ends.
• Trading bonds: Bondholders who buy and sell on the secondary market often try to profit from price fluctuations.

It’s important to note that after a bond is issued, the first buyer can resell it or trade it on what’s known as the secondary market. In fact, most investors buy bonds on the secondary market, not from the original issuer.

If you purchase a bond on the secondary market, the price may be dictated by many factors, including interest rates, market sentiment, macroeconomic conditions, perceived credit risk of the issuer, liquidity, and general supply and demand in the market for that bond.

Bond purchase options

A bond's yield moves inversely with the bond's price like the see-saw diagrams show below.

There are many reasons to invest in bonds. Most bonds are generally considered safer than stocks. Adding even a small amount of bonds to your mix of investments can help you diversify and significantly reduce volatility in your portfolio.

In addition, US Treasury and municipal bonds can offer investors potential income tax advantages.

When you’re ready to invest in bonds, you can open and fund a brokerage account and make your purchase. Explore E*TRADE’s comprehensive Bond Resource Center, available post-login, to find user-friendly tools and resources to help you find the bonds you want, according to your risk tolerance.