When you buy a bond, you're essentially lending the bond issuer (seller) money at a fixed interest rate. It's a straightforward way for companies, governments, or municipalities to generate financing for projects and innovations, so when they need money, they sell bonds to people like you. It's a good deal for both sides-sellers get the capital they need, and you get an investment that is typically more stable than stocks. Even better, since bonds are a debt the company owes you, its value isn't tied to the company's stock value.
The bond market is a general term that describes the buying and selling of debt securities offered by federal and local governments or corporations. New bonds are issued on the primary market, while existing bonds are sold on the secondary market. Bonds are basically bought and sold the same way as stocks—by matching buyers with sellers. But unlike stocks, buyers and sellers trade with one another (known as over-the-counter) over the phone, email, or through a broker.
Questions about bonds? We've got answers.
According to investment researcher Morningstar, long-term government bonds have returned between five and six percent since 1926.1 Because bonds often come with less risk than equities (stocks), they typically have lower average returns, but they're considered a more stable investment. Bonds are not a risk-free investment, however. There's the chance you won't get paid back (credit risk or default risk); the possibility of a decline in the bond market (market risk); the chance interest rates will rise, causing your lower-rate bond to be less appealing to a potential buyer prior to maturity (interest rate risk); and the chance that your bond won't keep pace with inflation (inflation risk).
If you buy a bond, you sit back and collect the interest payments while waiting for the bond to reach maturity (the date the issuer has agreed to pay back the bond's face value).
However, you can also buy and sell bonds on the secondary market before the maturity date. After bonds are initially issued, their price can fluctuate. If you hold them to maturity the fluctuations generally won't matter since the face value to be paid at maturity won't change and the interest collected along the way will be stable.
But if you want to buy or sell a bond, keep in mind that the price you'll pay or receive is no longer the face value of the bond. The bond's susceptibility to changes in value is an important consideration when choosing your bonds.