In our last post with a similar purpose, we discussed what a stock is and some of the terminology and uses that revolve around investing in stocks. See link to that post below to jump to that post if you did not read it already.

Around what “having your money invested” actually means, we are going to dive into the bond side of the investing spectrum.

So, let us start simply. What the heck is a bond? I will give you a few seconds to answer this for me because I know you are quite the brainiac and can figure it out. . . .

For all of you who do not know the answer or who are stumbling through a good answer, owning a bond represents you lending money to an “Issuer”, which is fancy talk for someone who is on record for borrowing the money. Bonds are also referred to as “Fixed Income”, because they traditionally represent a fixed interest rate or fixed return that the issuer has to pay to the person, or entity, they borrowed money from (just like if you borrowed money for a home purchase). Similar to Stocks, many of the people who own bonds do so through “funds”. You likely have heard of “Mutual Funds” or “Exchange Traded Funds”, which are some of the funds I’m referencing. If you have money in these funds, ones that are specifically bond funds, you are investing in the fund that owns the bonds, purchased by the investor money in the fund. You then get to enjoy the returns (interest payments from the money lent and sale proceeds if the bonds are sold) or losses those bonds are producing, in the fund.

Why do companies or governments issue bonds? Because they get your money that you lent them! Let us use Walmart in this post, just like our last. If Walmart wants to expand the number of stores or product lines they have, or they want to do improvements on their stores, they have four options:

1. They can spend their own money – If the company is making good profit, they can use some of their profits to cover the costs of these expansions or expenditures. But, just like your income, their profits are capped by the amount that is currently available and coming in. Depending on the costs of the projects or expansions, they may not have enough liquid money to cover everything they want.
2. They can sell small amounts of ownership of their company, in exchange for money they need – This is where the stock market comes in. Since Walmart is a publicly traded company, any Joe-Shmoe can buy small amounts of ownership (stock) in Walmart. Walmart then uses the sale of this ownership to fund their projects. It is a win-win, Walmart has more money to fund their company projects and the person or entity that owns the stock makes money when Walmart grows in value. If they want to buy back some of their ownership shares, they can find people who want to sell the stock and buy it back.
3. They can borrower money from lenders – Just like you borrow money from a mortgage lender to buy a home, companies can get commercial loans to fund projects. This often becomes a lot of extra work for large companies (in comparison to these other options), or may not have as advantageous of terms (in comparison to these other options). So companies make look for the other options listed.
4. They can borrower money from individuals or other institutions/governments – This is where bonds come in. A bond is just a loan. If you buy a corporate bond from Walmart, you are loaning Walmart money. They have to pay you back your loan amount over a certain amount of time, plus interest based on the interest rate negotiated. Once they borrow the money, they have money to complete their projects but need to pay back the debt over-time.

Since we are talking about bonds, specifically, in this post, I want to make sure I highlight this information. How can you make money while you sleep with investing in bonds? It is because all those companies or governments you loan money to are working day and night and have to pay you back. THEY are doing the work, not you. You lent them a certain amount of money at a certain interest rate or a certain payoff amount. Regardless of whether that company or government does exceptionally well that year or not, they have to make payments back to you (or bad things happen for them – credit ratings drop, etc.).

Bonds, in general, are considered lower risk than stocks because there is a fixed interest or payback component with the investment (whereas with stocks, there is no fixed return likelihood. You get what you get). On the flip side, since bonds are a “fixed income” category, you also often do not have the opportunity for high returns to the same extent you do with stocks. And, bonds still do have risk associated with them, which we will go into in more detail in later posts.

But, all-in-all, bonds are just loans you give to a company or government. The bond market is where people/entities can go to purchase bonds from these issuers (companies or governments). And, bond/fixed income Mutual Funds or Exchange Traded Funds are just pooling’s of investors (and their money) with a company that is going to invest that money (for the investors) into the bonds that are designated by the fund (per the funds goals).

Get it? Got it? Good?

Keep reading other posts to get a deeper dive into more investing basics.