When you buy a bond you are make a loan and they have to pay you back with interest. Companies as well as local, state, and federal governments issue bonds you can buy as an investment. Most bonds have a face value of $1,000, and a set interest rate they will pay for a fixed period of time. A bond with 4% interest that will mature (expire) in 10 years will pay you 4% interest, usually two times a year, for 10 years and then you get your initial $1,000 back. The interest payments are predictable and can be a steady source of income. Because of this they are generally considered less risky than stocks. Some government bonds don’t pay you the interest as you go along, but pay it all at the end. They are called a zero-coupon bonds and are issued for less than their face value.
Some bonds pay more interest than others. Like during COVID when overall interest rates are very low. Another key factor is how credit worthy is the issuer. The federal government is considered the most credit worthy. So they can pay lower interest rates on their bonds. A company that is struggling financially would have to pay the highest interest rates. Those bonds are typically called high yield or junk bonds. Lastly, bonds that are issued with a short maturity like 3 years will offer lower interest rates than bonds with a long maturity like 30-year.
You can buy federal government bonds directly from the government. And like stocks,you can buy individual bonds through exchanges, that is the market. But buying individual bonds to build a portfolio can be pretty complex. Part of the complexity is that a $1,000 almost always sells for a higher or lower price in the market where prices are based on supply and demand. Most individual investors get into bonds through a mutual fund or exchange traded fund (ETF). The funds buy many bonds to diversify and you own a slice of all that when you invest in the bond fund.
For our military and federal employees, you can invest in bonds through the Thrift Savings Plan. TSP offers two bond funds the F fund and the G Fund. The F Fund invests in a wide range investment grade (no junk bonds), US government and corporate bonds. The G Fund is unique. It invests in only US Government issued securities that are only available to TSP. It is guaranteed not to lose money and in that way is extremely safe. However, because it is so safe the interest the G Fund pays is also low and may not keep up with inflation.
I already mentioned the steady, predictable income that bond interest can provide. This may be especially useful when retire and could use the cash for regular expenses. Also bond prices tend to less volatile than stocks. So when stocks drop, bond usually values drop less or even increase some. This is really good if you will need to cash in some of your investments at a particular time, like for a home down payment, college tuition, or upcoming transition out of the military. Most likely your bond investments won’t grow as much as your stock investments, overall. But they are much less likely to plummet in value right before you need it.
In general, stocks are king when you can leave the money there and let it grow. If you're retirement that is still 30 years off, you may be in all stocks. Will you need to cash from your investment in a few years for a big purchase or for living expenses? Bonds are a steadier, safer bet. Just don’t expect a lot of growth. If you fall in between,mix of stocks and bonds may be ideal for you. Does a mix sound hard? You can invest in a TSP Lifecycle Fund or other target date fund. You choose a year you will need he money. The fund will automatically invest for you and gradually shift from stocks to bonds as you get closer.
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