Bonds

Did you ever think you'd make a loan to a huge corporation, the city where you live, or even to the US government? That's exactly what you're doing when you invest in corporate, municipal or government bonds.

Bonds are debt investments. When you buy a bond, you're lending your money, the principal you invest, to an issuer that needs cash. Most of these loans are for a specific period of time, called the bond's term, which can range from less than one year to 40 years or more.

How you make money with bonds

During a bond's term, you earn interest on your loan, which is the amount you invest to purchase the bond, just as you do on the money you deposit in a bank savings account. This is the bond issuer's way of compensating you for its use of your money. The interest is typically paid twice a year, though it may be on a different schedule.

The rate at which the interest is paid is usually fixed when you buy the bond and stays the same for the term, with longer-term bonds paying higher rates. This is to compensate you for lending money over a longer period of time. When the bond matures at the end of its term, the issuer promises to pay back your principal and any remaining interest.

The risk of default

One risk of buying bonds is that the issuer may not be able to meet its obligations to pay interest or repay principal. If that occurs, the issuer is in default and you could lose money. You can avoid bonds with the greatest risk of default by buying only those described as investment grade by the major bond rating companies. That includes bonds rated BBB or higher by Standard & Poor's and Baa or higher by Moody's Investor Services. Bonds issued by the US Treasury aren't rated because they're considered essentially free of default risk.