What is an investment bond?

Understanding bonds, their benefits, risks, and more.

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Key takeaways
  • Define bond investment: Bonds are loans to governments or corporations that pay interest and return principal at maturity.

  • Pros and cons of bonds: Bonds may provide predictable income, capital preservation, and diversification but come with risks like interest rate changes and inflation.

  • Choosing to invest in bonds: Choosing to invest in bonds depends on your goals, risk tolerance, and investment horizon.

What is a bond investment?

A bond investment is defined as a loan from an investor to a government or company in exchange for interest payments and eventual repayment. It is essentially like an “IOU,” allowing the borrower to use the money to fund its operations and the investor receives interest on the investment.

Key elements of a bond include the following: 

  • Issuer: The borrower of the money (e.g., a government or corporation).

  • Face value (Par value): The principal amount of the loan that the bond issuer agrees to repay to the investor when the bond matures.

  • Coupon rate: The annual interest rate the issuer agrees to pay the bondholder, often expressed as a percentage of the par value and paid at regular intervals (e.g., annually or semi-annually).

  • Maturity date: The official end of the bond’s term, where the issuer must repay the face value and any final interest payments to the bondholder.

  • Price: The current market value paid when buying or selling a bond.

  • Yield: The actual return an investor expects to receive when holding the bond to maturity (this takes its price, coupon rate, and time until maturity into account).

Three main types of investment bonds

There are many types of bonds available on the market, so it is essential to understand the differences between each type. Like many other investments, bonds also balance risk and reward, meaning lower-risk bonds will usually pay lower interest rates than higher-risk bonds. Therefore, it is also important to consider your risk tolerance when deciding to invest in bonds, and what type of bond.

The three main types of bonds include:

U.S. Treasuries

U.S. Treasuries are debt securities issued by the U.S. Department of the Treasury and are often considered a relatively low-risk investment since they are backed by the U.S. government. Treasury bonds often come with tax advantages such as exemptions from state and local taxes, but are still subject to federal taxes. However, due to the lower risk, they tend to pay lower interest rates than other bonds or investments.

Different types of Treasury debts include Treasury bills, notes, bonds, and inflation-protected securities (TIPS). These types can differ in interest rates and time to maturity (which can range from some weeks to 30 years). 

As of early 2025, 10-year Treasury notes yield around 4.30%, while 2-year notes yield about 4.60%, reflecting the current interest-rate environment.

Municipal bonds

Also known as munis, municipal bonds are debt securities issued by state or local governments to fund public projects like schools, highways, or hospitals. They often come with tax advantages such as exemptions from federal income tax or sometimes even state and local taxes. Munis can vary in term, often ranging from one year to over 10 years. Although defaults are rare, municipalities can face fiscal stress, so credit ratings (e.g., AAA vs. BBB) matter when evaluating risk and yield.

Corporate bonds

Corporate bonds are debt securities issued by companies to raise money for business activities such as expansion or acquisitions. They tend to offer higher yields than government bonds but also carry more risk since repayment depends on the company’s financial health. However, unlike buying stocks in a company, corporate bonds do not give you ownership. Corporate bonds are categorized by credit rating — “investment grade” (BBB–/Baa3 or higher) and “high-yield” or “junk” (below BBB–/Baa3) — which affects both risk and potential return.

Pros and cons of bond investments

Before purchasing a bond, it’s important to consider the potential benefits and drawbacks to see if they align with your financial goals.

Here are some potential pros and cons of investing in bonds:

Potential benefits of bond investments

  • Steady cash flow: Bonds typically pay fixed interest (coupon payments), offering predictable income.
  • Lower- to moderate-risk investments: Government and investment-grade bonds generally offer the lowest-risk bond option, and bonds are generally less volatile than other investments such as stocks.

  • Capital preservation: Bonds often help protect your principal (and earn interest), particularly when held to maturity.

  • Portfolio diversification: Bonds often move differently from stocks, especially in periods of economic slowdown or risk aversion, which can help reduce overall portfolio volatility.

  • Tax advantages (in some cases): Municipal bonds may provide federal and sometimes state/local tax exemptions. Treasury bonds are exempt from state and local taxes, but federal taxes still apply.

Potential drawbacks of bond investments

  • Lower long-term returns: Bond returns are usually less over the long term compared to stocks or some other investments.
  • Interest rate risk: Bond prices tend to fall when interest rates rise, which can potentially hurt your returns if you sell before maturity.

  • Credit/default risk: Some issuers may fail to make payments.

  • Inflation risk: Rising inflation can erode the real value of bond interest and principal over time.Liquidity risk: Some bonds may be harder to sell quickly without losing value.

Are bonds right for you?

When determining if bonds are the right investment option for you, it’s important to do your research to fully understand the bond terms and be aware of any potential risks you may face. Now that you have a better understanding of how investment bonds work, you may want to see if your bond of interest is in alignment with your financial goals, risk tolerance, and investment horizon

While bonds are often used in portfolio diversification as part of greater asset allocation strategies, you still need to be aware of potential losses you may face to determine if and how they can fit into your investment strategy. You might also want to consider seeking professional advice from a financial advisor before making any big financial decisions.

Bottom line

While bonds can offer investors unique benefits, they are not risk-free. Factors like interest rates, creditworthiness, and inflation can impact returns. Before investing, make sure bonds align with your financial goals and risk profile. If you’re unsure, consulting a financial advisor can help you determine the best mix of investments for your strategy.

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FAQs on bond investments

How do bonds make money for investors?

Bonds generate income through fixed interest payments (coupon payments), and investors also get their principal back at maturity. If sold before maturity, investors may also make (or lose) money depending on market conditions.

What is the difference between stocks and bonds?

Stocks represent ownership in a company and offer potential for growth through dividends and price increases, but come with a higher risk. Bonds are loans to issuers that provide fixed income and are generally less risky, but may result in lower long-term returns.

Can you lose money investing in bonds?

Yes. If interest rates rise, bond prices can fall, leading to losses if sold early. Credit risk, inflation, and liquidity challenges can also reduce returns. Holding high-quality bonds to maturity can potentially help reduce this risk.

What happens when a bond reaches maturity?

At maturity, the bond issuer repays the face value (principal) to the investor, along with any final interest payments.

The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.