Have you ever wondered what bonds are and how they work? If you have a managed investment account like a 401k or an IRA account, chances are you have bonds somewhere in your portfolio. But what exactly is a bond, and how does it work?
During the "Her Money and Investing Show: Bonds for Beginners," Joanne Spears, CRPC™, CSRIC® from Merrill Lynch Wealth Management, taught us about the basics of bonds. We learned that a bond is like giving a loan to the government or a company. When you buy a bond, you're essentially lending money to the issuer, who promises to pay you back the principal (the amount you loaned) with interest (also known as a coupon) after a certain period of time (the term).
Just like a mortgage, the loan has an amount (principle), a term, and the interest they pay you (or coupon). Bonds can have different terms, ranging from a few months to several years or even decades. The interest rate (coupon) you receive depends on the issuer's creditworthiness (credit rating) and the bond's term.
Joanne brought up the concept that a bond issuer's creditworthiness is like an individual's credit score. Just as your credit score reflects your creditworthiness as a borrower, the credit rating of a bond issuer reflects their ability to repay the loan. Basically, the higher the credit rating, the lower the risk of default, and the lower the interest rate (coupon) offered on the bond.
During the show, Joanne Spears gave an example to illustrate that a government bond issued by a country with a high credit rating, such as the United States, typically has a lower interest rate (coupon) than a bond issued by a company with a lower credit rating. This is because the US government is considered a more reliable borrower than a company with a low rating and, therefore, may pose a lower risk of default.
We also learned that bonds, like all investments, carry risks. Therefore, it's essential for an individual to research and understand the risks before investing in bonds.
If you want to learn more about bonds and hear the entire conversation with Joanne Spears, CRPC™, CSRIC® from Merrill Lynch Wealth Management, check out the "Her Money and Investing Show"'s newest episode "Bonds for Beginners." She gives a fantastic primer on bonds, and her insights and knowledge are invaluable.
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Jessica Perrone, Founder, Her Financial IQ Show Host, Her Money & Investing Show
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