Jul 30, 2025
Key Takeaways
- Bonds are debt securities, or loans that investors make to governments or companies that pay set interest over time and repay the principal when the bond matures.
- Bonds can help balance your portfolio by providing steady income, reducing volatility and offering a lower-risk alternative to stocks, which can be especially useful in retirement or during market downturns.
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Bonds aren’t as flashy as stocks, but they can be a smart, steady investing option to balance your portfolio. If you’ve ever loaned a friend money and expected to be paid back with interest, then you may have already held one. Below, the MarketWatch Guides team covers what bonds are, how they work and why they might deserve a spot in your portfolio.
What Are Bonds?
A bond is a loan that an investor makes to a government or company, which is known as the bond issuer. When you buy a bond, you become the bondholder. In return for your loan, the bond issuer agrees to pay you regular interest for a set amount of time and repay the original amount you loaned them when the bond matures. The bond’s face value is the original amount of the bond, and the coupon amount is the amount of interest you receive.
Governments and companies issue bonds for many reasons. A town might issue a bond to fund the cost of building a new road or bridge. A health care company could issue bonds to pay for the cost of research to develop a new drug.
How Do Bonds Work?
Bonds are a type of investment known as fixed-income securities. They get the name because of the fixed interest payments they provide. Investors generally add bonds to their financial portfolios because they provide income and stability and tend to be less volatile than stocks.
Credit-rating agencies such as S&P Global and Moody’s give bonds ratings based on their creditworthiness. Bonds with the highest ratings, such as AAA, have the lowest default risk. Bonds with the worst ratings, such as C or D, which tend to be corporate bonds issued by less-reputable companies, carry higher default risk.
To trade bonds, you can do so through a brokerage platform or exchange, similar to how you buy and sell stocks. Bonds can be traded in two main ways:
- On the primary market: When you purchase bonds directly from the entity that issued them, such as the U.S. Government, you’re buying them on the primary market. You can purchase directly from government websites, through municipal securities dealers or through brokerages, directly from the issuer in some cases. You can buy a bond and hold it until it matures and then cash it in to collect the face value.
- On the secondary market: After bonds have been issued on the primary market, they’re often bought and sold in the secondary bond market before their maturity date. You can buy and sell bonds in the secondary market through most brokerages.
Once a bond is traded on the secondary market, its value is no longer fixed. Its price can fluctuate based on interest-rate movements and market conditions. If interest rates increase, your bond may lose value since newer bonds will likely have higher yields, making your bond less attractive by comparison. If interest rates decrease, your bond could be worth more because it’s more appealing compared to newer bonds with lower yields.
You can buy and sell individual bonds on the market or buy and sell bond funds, which are collections of many different bonds in one mutual fund or exchange-traded fund.
Pros and Cons of Bonds
Bonds can provide stability and income, though they usually offer lower returns than stocks. For example, since 1957, the average nominal return, not adjusted for inflation, of 10-year Treasurys is 5.7%, according to the Federal Reserve, while the average nominal return of the S&P 500 stock index is 10.5% for the same period, according to OfficialData.org.
Pros
Steady income: Bonds are known to provide predictable returns with steady income payments several times per year.
Stability: Bonds tend to be more stable investments than equities, with less price volatility, so they can act as anchors in your portfolio.
Tax benefits for municipal bonds: If you buy municipal bonds issued in the state you live in, the interest income may be exempt from federal, state and local taxes.
Cons
Lower returns: Like many less-volatile investments, bonds and bond funds generally produce lower returns than stocks, especially over the long term.
Inflation risk: Bonds are susceptible to inflation because of the fixed return they pay. If inflation increases quickly, bond values can take a hit if you’re selling them on the secondary market.
Risk of default: Although some bonds, such as U.S. Treasurys, are considered very safe investments, other bonds have lower credit ratings because their issuers could default on interest or principal payments.
Types of Bonds
There are four main types of bonds in the U.S.: government, municipal, corporate and agency. You can also buy international bonds from some brokerages, although bonds issued by foreign governments generally aren’t considered as safe as bonds issued by the U.S. government. Many investors prefer to invest in bond funds rather than individual bonds because they provide built-in diversification with large collections of bonds.
Government Bonds
The U.S. Department of the Treasury issues different types of bonds collectively known as U.S. Treasurys, which can be purchased through TreasuryDirect. They’re some of the safest investments in the world, backed by the full faith and credit of the U.S. government.
There are several types of U.S. Treasurys, including bills, notes and bonds. The main difference between the three is how long they take to mature. Treasury bills have terms of four to 52 weeks and pay interest at maturity. Notes mature in two to 10 years, and Treasury bonds have terms of 20 or 30 years. Both pay interest every six months.
The U.S. Treasury also issues Treasury Inflation-Protected Securities, which increase the bond’s principal if inflation increases before the maturity date. TIPS are available in terms of five to 30 years. You can also purchase savings bonds, which start at $25 and earn fixed rates of interest every year.
“U.S. Treasurys are often thought of as a risk-free investment, but like all bonds, they are exposed to inflation risk. Theoretically, TIPS provide the same safety as Treasurys, while compensating for inflation. TIPS are therefore quite safe investments. But because inflation expectations are priced in, they don’t often provide great returns unless inflation exceeds expectations.”
Expert insight from Asher Rogovy
Municipal Bonds
Municipal bonds are offered by state and local governments to finance capital projects such as building new schools. Interest payments from municipal bonds are often exempt from federal income taxes, and they may be exempt from state and local taxes if you buy the bonds from a government in the state where you live. Many brokerage firms sell municipal bonds, and you can also purchase them directly through certain municipalities.
Corporate Bonds
Corporate bonds are issued by public and private companies that need to raise money, and you can buy them through most brokerages. There are two main types of corporate bonds:
- Investment-grade bonds: These have higher ratings and are generally considered safer investments. As a result, their yields tend to be lower.
- High-yield bonds: Also known as junk bonds, high-yield bonds have lower credit ratings. However, they tend to have higher rates of return because they’re riskier investments.
If you purchase high-yield bonds, understand that the bond issuer could default, leaving you with nothing.
Agency Bonds
Many brokerages offer agency bonds, which are issued by government-sponsored enterprises, such as Fannie Mae and Freddie Mac, and government agencies, such as the Federal Housing Administration. While these bonds aren’t technically backed by the U.S. government like Treasurys are, there’s an implied backing. For this reason, agency bonds tend to have lower yields than Treasurys.
International Bonds
International bonds are issued by foreign governments that are looking for inexpensive ways to borrow money. Governments can reach more investors if they sell bonds internationally. International bonds that are issued and traded within the U.S. are called yankee bonds. Eurodollar bonds are traded outside of the U.S. Many large brokerages have international bonds.
Bond Funds
A bond fund isn’t a unique type of bond, but many investors buy them to diversify their bond holdings. Bond funds can be either domestic or international and available as both mutual funds and ETFs. Bond funds tend to have low expense ratios, which are the annual costs of maintaining the funds. This makes them ideal for investors who want the stability of bonds in their portfolios without having to manage interest payments and maturity dates.
Are Bonds a Good Investment for You?
Bonds can play important parts of many investors’ portfolios, especially for diversifying and stabilizing investments. But if you’re a younger investor who’s looking for high growth or there’s a highly inflationary environment, holding a large portion of bonds in a diversified portfolio may not be the best choice.
When You May Consider More Bonds in Your Portfolio
Bonds may make up a higher percentage of your total investing portfolio in these scenarios:
You’re Nearing Retirement or Are Already Retired
Bonds can provide steady income and preserve your initial capital if you hold them until maturity. Because of this, they’re used by investors who have a shorter investing horizon or by those who are more interested in creating steady income streams, such as retirees.
You Want To Reduce Risk in Your Portfolio
Investing in bonds or bond funds allows you to decrease the overall volatility of your portfolio while typically sacrificing little in returns. A classic 60/40 portfolio — 60% stocks and 40% bonds — can reduce your chances of seeing big drops in your nest egg, according to Morningstar.
You Want Diversification
Bonds can act as a counterbalance to stocks. When stock markets decline, high-quality bonds often hold their value or even increase in value, helping cushion your overall losses. You can help balance your returns over time by including bonds in your portfolio, especially during periods of market turbulence.
When You May Consider Fewer Bonds in Your Portfolio
You may want to consider a lower percentage of bonds in your portfolio under the following circumstances:
You’re Seeking High Growth
Bonds tend to provide lower long-term returns than stocks. If your primary goal is to grow your wealth significantly, especially over several decades, consider that stocks are likely to outperform bonds.
You’re Investing in a High-Inflation Environment
Because bonds pay fixed interest rates, inflation can eat into your real returns. When inflation rises quickly, the interest from bonds may not be enough to preserve your purchasing power, especially if you’re holding longer-term bonds without inflation protection.
You Have a Long Investing Horizon
If you’re in your 20s or 30s and decades away from needing your money, heavily investing in bonds may limit your growth potential. Younger investors typically benefit from more stock-heavy portfolios that can capture higher returns over time even if they produce short-term volatility.
Frequently Asked Questions About Bonds
A bond is, in simple terms, a loan that an investor makes to the government or company. In return, the investor gets regular interest payments during the life of the bond, and the principal amount is returned when the bond matures.
A $1,000 savings bond could be worth at least $2,000 after 20 years. An EE savings bond is guaranteed to double in value during that time, according to TreasuryDirect. It would continue to earn interest at a fixed rate during the next 10 years, possibly increasing its worth to over $2,500, depending on the interest rate. Because the overall rate for an I bond changes based on inflation, estimating that type of savings bond’s value after 30 years is more difficult.
A $100 savings bond from the U.S. Treasury matures in 30 years, whether it’s an EE bond or an I bond. While EE bonds sold since May 2005 earn a set interest rate for at least 20 years, I bonds’ rates change every six months based on inflation. Both types of savings bonds pay out interest when you cash them in, which you can do after 12 months.
Bonds make you money by paying you interest. Typically, interest payments are issued every six months on the amount you bought the bond for, and then your principal is returned to you when you cash the bond in at maturity. You can also buy and sell bonds on the secondary market. Bonds’ values can rise and fall depending on the current interest rate, so you can make money on a bond this way if interest rates have dropped since you bought the bond.
*Data accurate at time of publication
*The content provided in this article is for informational purposes only and should not be construed as financial, investment or tax advice. You should consult a licensed financial adviser or tax professional before making any investment decisions. All investments carry risks, including the possible loss of principal. Past performance is not indicative of future results.