I have discussed mutual funds on this site before, but the term "bond" often appears. Most mutual funds have a combination of cash, stocks and bonds. Some funds specialize only in bonds. In order to be confident that you invest wisely, you should know the basics of bonds.
When a person wishes to purchase a house or car, the bank loans the money for the acquisition in return for an agreed interest rate and payment schedule. Just as people need money; so do companies and governments. A company needs funds to expand into new markets, while governments need money for everything from infrastructure to social programs. These large organizations typically require far more money than the average bank can provide at a reasonable cost as a loan. The solution is to raise capital by issuing bonds that are sold on a public market. Thousands of investors buy bonds to lend a portion of the capital needed.
Buying a bond is just like being a bank or a credit union and loaning money to someone. A bond is similar to an I.O.U. When you purchase a bond, you are the lender of money to a government, municipality, corporation, federal agency or some other entity. The organization receiving the money is known as the issuer. In return for the loan, you are promised an interest rate and repayment period for the principal.
Among the types of bonds you can choose from are:
- U.S. government securities
- municipal bonds
- corporate bonds
- mortgage or asset-backed securities
- federal agency securities
- foreign government bonds
You should maintain a portfolio that consists of bonds, stocks, and cash. Bonds typically have a predictable stream of payments and repayment of principal. Investing in bonds can provide reliable interest income.
Since a mutual fund may often have a portion of its holdings in bonds, you are taking advantage of this "loaning" of money. The precise blend of cash, bonds, and stocks that would be most optimal for you cannot be advised in a book or a website. I discuss this more in the last chapter of my book, The Confident Investor, where I talk about other things that you may want to research. In general, a bond will provide a more stable but smaller return than an investment in individual stocks.