Bonds
Lending your money to a government or company in exchange for regular interest - steadier than stocks, but not risk-free.
Core Concepts
Six ideas that explain how bonds behave and where they fit.
A bond is a loan with a schedule
You lend money to a government or company. They pay you interest (the coupon) on a set schedule, usually every six months, and repay the original amount (the face value) on a set date (the maturity). Buy a $1,000 bond with a 4% coupon and you receive $40 a year, then your $1,000 back at the end.
When rates go up, bond prices go down
If you own a bond paying 4% and new bonds start paying 5%, nobody will pay full price for yours - so its market price drops until it's competitive. The reverse happens when rates fall. This is the single most important thing to understand about bonds. Try it in the calculator below.
Holding to maturity changes the picture
Price drops only become real losses if you sell. Hold an individual bond until it matures and, as long as the issuer doesn't default, you get the full face value back no matter what rates did along the way. Bond funds never mature, so they don't offer that guarantee - the broad U.S. bond market fell about 13% in 2022 as rates rose quickly.
Longer bonds swing more
The longer until a bond matures, the more its price moves when rates change, because you're locked into its rate for longer. A 30-year bond can swing about as much as stocks do; a 1-year bond barely moves. Longer bonds usually pay a higher rate to make up for that risk.
Riskier borrowers pay more
The U.S. government is the safest borrower, so Treasuries pay the least. Companies pay more to compensate for the chance they can't pay you back, and the shakier the company, the higher the rate. A bond with an unusually high yield is almost always signaling higher risk, not a free lunch.
Why hold bonds at all?
High-quality bonds often hold up better than stocks during a crash, so mixing them in smooths out the ride - smaller gains, but smaller drops too. They also provide steady income, and they're a common way to lower risk as you get closer to needing the money, like near retirement. Historically they've returned roughly 4-6% per year before inflation, versus about 10% for stocks.
Types of Bonds
Who you lend to determines the risk, the yield, and how the interest is taxed.
| Type | Issued by | Risk | Tax on interest | Worth knowing |
|---|---|---|---|---|
| Treasuries | U.S. government | Lowest | Federal only - no state or local tax | Bills mature in a year or less, notes in 2-10 years, bonds in 20-30 years. |
| TIPS | U.S. government | Lowest | Federal only | Principal adjusts with inflation (CPI), protecting your purchasing power. |
| I Bonds / EE Bonds | U.S. government | Lowest | Federal only, and can be deferred until you cash out | Savings bonds sold only at TreasuryDirect. I Bonds track inflation; $10,000 per person per year limit; must hold 1 year, and cashing out before 5 years costs the last 3 months of interest. |
| Municipal ("munis") | States, cities, school districts | Low | Usually federal-tax-free; often state-tax-free if you live in the issuing state | Lower stated yields, but the tax break can make them pay more after tax in higher brackets. |
| Investment-grade corporate | Financially strong companies | Moderate | Federal and state | Rated BBB/Baa or higher. Pays more than Treasuries for a modest step up in risk. |
| High-yield ("junk") | Less financially stable companies | Higher | Federal and state | Rated below BBB/Baa. Higher yields, meaningful default risk, and they tend to fall alongside stocks in a downturn. |
Key Terms
Grouped by what they describe.
The bond itself
- Issuer
- Who is borrowing your money: the U.S. Treasury, a state or city (municipal bonds), or a company (corporate bonds). The issuer decides how safe the bond is and how its interest is taxed.
- Face value (par)
- The amount repaid at maturity, usually $1,000 per bond. Bond prices are often quoted as a percent of par: a price of 95 means $950.
- Coupon
- The fixed interest rate the bond pays on its face value. A 4% coupon on $1,000 pays $40 a year, typically as two $20 payments.
- Maturity
- The date the issuer repays the face value and the bond ends.
- Premium / discount
- A bond trading above face value is at a premium (its coupon beats today's rates); below face value is at a discount (its coupon is below today's rates).
Yield and price
- Yield to maturity (YTM)
- Your total yearly return if you buy at today's price and hold to maturity, counting both interest and any gain or loss back to face value. The best single number for comparing bonds.
- SEC yield
- A standardized yield that bond funds are required to report, after fees. Use it to compare funds with each other.
- Duration
- A measure of rate sensitivity, in years. Rule of thumb: a duration of 6 means roughly a 6% price drop if rates rise 1 percentage point, and a 6% gain if they fall 1 point. Every bond fund lists its duration.
- Yield curve
- A chart of Treasury yields from short to long maturities. Normally longer maturities pay more. When short-term rates are higher than long-term ones, the curve is "inverted", which has often come before recessions.
Risk
- Interest rate risk
- The risk that rising rates push your bond's price down. The biggest risk for high-quality bonds.
- Credit rating / default risk
- Agencies like S&P and Moody's grade how likely an issuer is to pay you back. BBB-/Baa3 and above is "investment grade"; below that is "high yield". A default means missed payments and possibly losing part of your money.
- Inflation risk
- A fixed payment buys less as prices rise. A 4% bond during 5% inflation is losing purchasing power. TIPS and I Bonds are designed to address this.
- Callable bond
- A bond the issuer can repay early - usually when rates fall, which is exactly when you'd want to keep it. Callable bonds pay a bit more to compensate.
Rates vs Price Calculator
See what a bond you own is worth if you sell before maturity, after market rates move.
Assumes interest is paid twice a year and the issuer doesn't default. Results update as you type.
| If market rates were | Bond price | Change vs face value |
|---|
Bond ETFs for Beginners
Low-cost funds that cover the main corners of the bond market. Any of these can be bought at a typical brokerage.
| Ticker | Fund | What you're buying | Rate sensitivity | Expense ratio |
|---|---|---|---|---|
| Core: the whole bond market | ||||
| BND | Vanguard Total Bond Market ETF | Thousands of investment-grade U.S. Treasury, government-agency, and corporate bonds. | Medium | 0.03% |
| AGG | iShares Core U.S. Aggregate Bond ETF | Very similar to BND, from iShares. Pick one or the other. | Medium | 0.03% |
| BNDX | Vanguard Total International Bond ETF | Investment-grade bonds from outside the U.S., with currency swings hedged out. | Medium | 0.07% |
| Short-term Treasuries (steadiest) | ||||
| SGOV | iShares 0-3 Month Treasury Bond ETF | Treasury bills maturing within 3 months. Behaves much like cash - see Cash Equivalents. | Very low | 0.09% |
| VGSH | Vanguard Short-Term Treasury ETF | Treasuries maturing in 1-3 years. | Low | 0.03% |
| Special purpose | ||||
| SCHP | Schwab U.S. TIPS ETF | Inflation-protected Treasuries (TIPS). | Medium | 0.03% |
| VTEB | Vanguard Tax-Exempt Bond ETF | Municipal bonds whose interest is generally federal-tax-free. Best suited to a taxable account in a higher tax bracket. | Medium | 0.03% |
| VCIT | Vanguard Intermediate-Term Corporate Bond ETF | Investment-grade corporate bonds maturing in 5-10 years. A bit more yield than BND, a bit more risk. | Medium | 0.03% |
| TLT | iShares 20+ Year Treasury Bond ETF | Long-term Treasuries. Included as a caution: very safe from default, but it lost about 31% in 2022 when rates rose. | High | 0.15% |
Start broad
For most beginners, one total bond market fund like BND or AGG covers it. It's the bond piece of the classic "three-fund portfolio" described on the Stocks page.
Match the timeline
Need the money in 1-3 years? Short-term Treasury funds barely move when rates change. Money for 5+ years out can handle a total bond fund's moderate swings.
Mind the account
Bond interest is taxed as ordinary income, so taxable bond funds often go in a 401(k) or IRA. Muni funds like VTEB are already tax-exempt, so they belong in a regular taxable account.
Ready to buy? The step-by-step guide is in Investing Basics under "Start Here".
Expense ratios change occasionally - confirm the current figure on the fund provider's website before buying. This list is educational, not a recommendation to buy any specific fund.