Bonds
A bond is a promise to repay borrowed money: an investor loans cash to a government, PSU, or company for a fixed term and, in exchange, receives regular interest (the coupon) plus the original amount (the principal) at maturity. It is a core building block in steady-income portfolios where predictability matters.
Bonds can play different roles - financing infrastructure projects, helping businesses expand, or letting governments fund essential services. They are simpler than equities for many people because you know when the interest comes and when the loan is returned, unless there is a default. For return comparison across periods, review CAGR.
When you buy a bond, you become the lender, not the owner. Your return comes from the interest the issuer promised, rather than from share prices moving up or down.
Key aspects of bonds
- Issuer: Governments, municipal bodies, and corporations issue bonds to borrow. Sovereign and high-rated AAA bonds generally carry lower risk than corporate or lower-rated debt.
- Coupon rate: This is the fixed interest you receive, expressed as a percentage. Higher coupon rates compensate for higher risk or longer duration.
- Maturity: Bonds can last from a few months to decades. Shorter maturities reduce interest-rate risk, while longer ones lock in income for a longer period.
- Credit risk: Rated by agencies, it reflects how likely the issuer is to pay interest and principal on time.
- Price vs yield: If interest rates rise, existing bond prices fall and vice versa. Yield shows your effective return, considering the current market price.
How bonds deliver returns
Income and capital protection are the two pillars of bond returns. Investors get consistent coupon payments, and at maturity the full principal back if the issuer stays solvent. There are also scenarios when bonds are bought or sold before maturity, allowing capital gains if yields drop after purchase.
- Periodic interest: Coupons are paid monthly, quarterly, semi-annually, or annually depending on the bond.
- Holding to maturity: Locks in your yield if the issuer repays, making budgeting easier.
- Reselling: Trading on exchanges lets investors lock in gains or adjust portfolios.
- Reinvestment: Coupon payments can be reinvested in other bonds or funds to compound returns.
Why bonds matter for everyday investors
Not everyone wants the volatility that comes with equities. Bonds add stability, regular cash flow, and diversification when paired with growth assets. They also suit goals like funding a child's education or creating an emergency buffer because of their predictable structure.
- Preserving capital: Bond principal is easier to protect, especially in high-quality sovereign or PSU debt.
- Matching goals: Align the maturity with when you need the money, making planning precise.
- Income consistency: Reliable coupons help build systematic cash flow for retirees or savers.
- Portfolio diversification: When equity markets wobble, bonds usually behave differently, smoothing performance. Learn diversification.
Things to check before buying a bond
- Credit rating: Higher ratings (AAA/AA) signal stronger repayment ability; lower ratings pay more, but risk default.
- Interest-rate risk: Bond prices fall when new bonds offer higher yields. Longer maturities are more sensitive.
- Liquidity: Some bonds are thinly traded, so selling quickly could mean sacrificing price.
- Tax treatment: Interest income is taxable. Consider investments like tax-free or infra bonds if you want relief, and align with tax planning.