Companies have the ability to raise money in a lot of different ways. If they want to let investors own a part in their company, they will sell stock. If they want to borrow money, they may go to a bank or they might borrow money directly from an investor in the form of a bond. A bond basically works like a loan. The company who issues the bond is considered a borrower and the investor who lends their money to the company is considered the lender.
Some bonds have different rules and terms but generally speaking, you receive interest payments (called coupon rates) up until the agreed upon date when you get your initial investment back paid in full (called the maturity date).
Advantages of Bonds
One of the major advantages a bond has over a stock is how the investor gets paid. Bonds pay interest on a regular basis, whether that’s quarterly, semi-annually, or annually.
Another great benefit is that they generally carry more security from market volatility. The values of bonds do fluctuate, but not as much as stocks. Let’s use the example of Apple (AAPL) as an example.
AAPL stock has consistently grown more valuable since their initial public offering. However, there are periods of time where Apple, like many companies, endures stagnant sales usually occurring after one of their products isn’t as successful as they had hoped for. In these time periods, their stock typically takes a hit and loses value.
Bonds, on the other hand, fluctuate differently than stocks. During times of stagnant sales or market downturn, the creditworthiness of Apple remains relatively untouched. In other words, even though Apple may be experiencing a period of sales stagnation, nobody doubts the value of the company as a whole and their ability to recover.
Arguably the biggest driver of the value of bonds is interest rates. Interest rates and bonds move in an inverse fashion to one another. As interest rates go up, the value of existing bonds will have to drop so that the interest payment will be equivalent to the new higher interest rate in the market. As interest rates go down, the value of existing bonds will have to rise so that the interest payment will be equivalent to the new lower interest rate in the market.
Bonds generally will not make the same amount of money as stocks, but they are less volatile. That’s not to say that bonds don’t carry any risk. Like all investments, bonds can have hidden risks. It’s important to have a mix of both stocks and bonds in your portfolio to offset some of the market risks.