What Is a Bond?

When you buy a stock, you become part owner of the company. When you buy a bond, you are making a loan; you are simply lending money to a company (corporate bonds) or to a government (for U.S. investors, this is most commonly the U.S. government). Because U.S. government bonds (also known as Treasuries) are issued and guaranteed by Uncle Sam, they typically offer a modest return with low risk. Corporate bonds are issued by companies and carry a higher degree of risk (should the company default) as well as return.

How a bond works

Your loan lasts a certain period of time—until the date that the bond reaches maturity, when the principal of a bond is repaid. In the meantime, you can typically expect income payments (commonly known as coupons) as interest on the loan. Thus, the essential issues for bond investing will be the bond's maturity, how much interest it pays, and how confident you are that the business or government can actually repay the loan.

Because of their fixed interest payments and the promise of repayment at maturity, bonds are considered less risky than stocks, though they historically have also returned less than equities. So if you're buying a bond fund to give your portfolio stability or to help generate income, then your strategy may pay off. But if you think you can't lose money in bonds, guess again.