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What are Bonds? Discussing the Archaic Investment

Bonds, also known as “fixed income” assets, are an age-old investment that your grandparents probably owned. Bonds revolve around debt; when you purchase a bond, you are loaning a company or government (yes, a country) your money. When you purchase a bond, the institution you are buying it from promises to pay you back interest, like with a normal loan.

You will receive these interest payments periodically, sometimes monthly, other times annually, until the maturity date. Bonds have “lifetimes” varying from only a month up to decades. This means you loan your money to the company/government and they pay you up until the bond reaches the predetermined time, which is called the maturity date. Once the bond reaches maturity, the company or government will pay you back the face value of the bond. You can consider this “paying back the loan”.

Bonds, just like any other tradable asset, fluctuate in price. This means bonds will increase or decrease in price based on supply and demand; the more people that want a specific bond, the higher the price, and vice versa. One key difference between bonds and stocks is that bonds are traded over the counter, meaning you must buy them from a broker, and not over an exchange like stocks. I’ll discuss the more nuanced elements of bond pricing and interest rates in a coming article,

The biggest benefit to investing in bonds is the element of safety. Because bonds are essentially loans to corporations or governments, they are almost guaranteed to be paid back, unless the corporation/government fails. The institution is backing the bond, so unlike stocks, you are guaranteed to receive payments periodically, and receive the face value of the bond upon maturity. With stocks, there is no such guarantee.

The biggest downside, and the reason many people don't invest in them, is the small returns/profits. Because bonds essentially guarantee payment, the interest payments are very small, usually under 5% a year, on the higher end. Many bonds can be as low as 1-2%. When you compare this with the stock markets average of 9% a year, it seems like a no-brainer. Well, this is where the risk-return tradeoff comes into play. If you can afford to take more risks and sit out market downturns (usually younger people), the stock market is right for you. If you're older (which I doubt many of my readers are), perhaps nearing retirement, you don't want your money to take even the slightest hit, and you don't mind getting less profit in exchange for that security.

In short, bonds are assets you receive in exchange for loaning a corporation or government money. In exchange for owning an institution's bonds, you receive periodic payments in the form of interest. These interest payments are generally very low, and on average, the stock market has beaten the returns of bonds by a significant margin. However, bonds are a safe investment, making them prime for people who prefer low risk and don't mind low returns as a result. For younger investors who have decades left in the financial markets and can take more risks, other investments may be more favorable.

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