A bond is a loan you make to a government or a company. They pay you a fixed rate of interest (the coupon) and return your money (the principal) on a set date. Bonds are how governments fund roads and companies fund factories — and how savers get a predictable income stream.
The five pieces of every bond
- Face value — usually $1,000. This is what gets repaid at maturity.
- Coupon — the interest rate paid on face value. A 4% coupon on $1,000 pays $40 a year.
- Maturity — the date the principal comes back. Two years and thirty years are very different investments.
- Price — what the bond trades for today, which may not be $1,000.
- Yield — the return you get if you buy at today’s price and hold to maturity.
Why prices and yields move in opposite directions
This is the part that confuses everyone, and it comes from one simple fact: the coupon is fixed, but market interest rates are not.
You own a bond paying 4%. New bonds now pay 5%. Nobody will pay you full price for your 4% bond when they can buy a 5% bond instead — so the price of your bond falls until its effective return matches the market.
| Market yield | Price of a 4% 10-year $1,000 bond |
|---|---|
| 3% | $1,085 |
| 4% | $1,000 |
| 5% | $923 |
Read that table twice. A one percentage point move in rates moves a ten-year bond by roughly 8%. Longer maturities move more.
A worked example
You buy a $1,000 bond with a 4% coupon maturing in ten years. You collect $40 a year.
Rates rise to 5% the next day. Your bond is now worth about $923 if you sell. You have lost $77 on paper.
But if you hold to maturity, you still get $1,000 back plus $400 of coupons. The loss only becomes real if you sell early. That is the difference between price risk and credit risk.
The main types
- Government bonds — the safest credit, the lowest yield. US Treasuries, UK gilts, German bunds.
- Municipal bonds — issued by states and cities, often tax-free in the US.
- Corporate bonds — higher yield, higher default risk. “Investment grade” means lower risk; “high yield” means junk.
- Inflation-linked bonds — principal adjusts with inflation, which protects purchasing power.
Most people own bonds through a fund rather than buying individual issues, which spreads default risk across hundreds of borrowers.
The four risks
- Interest-rate risk — prices fall when rates rise. Bigger for longer maturities.
- Credit risk — the borrower cannot pay. Small for governments, real for companies.
- Inflation risk — a fixed 4% coupon is worth less every year prices rise. This is the risk cash savers underestimate; see what inflation does to savings.
- Liquidity risk — some bonds are hard to sell quickly without a discount.
Why hold bonds at all
Bonds usually fall less than shares in a crash and sometimes rise when shares fall, because central banks cut rates in a recession. That is diversification, not magic: in 2022 both fell at once when rates rose sharply.
The right question is not “are bonds good?” but “how much of my portfolio should be bonds?” That is an asset allocation decision, driven by your time horizon and how much volatility you can tolerate.
Common mistakes
- Thinking a bond fund is risk-free. It has no maturity date, so it never “gets its money back” the way a single bond does.
- Chasing yield without checking duration. A long-dated fund can lose 15%+ when rates rise.
- Ignoring the real return. A 4% bond with 3.5% inflation and tax is barely keeping up.
- Assuming bonds always offset shares. It usually works, not always.
How to use this in a decision
- Decide what the money is for and when you need it.
- Under three years, keep it in cash or short-dated bonds rather than long ones.
- Compare the yield after fees and tax to inflation.
- Prefer broad bond funds over single issues unless you can evaluate credit risk yourself.
Frequently asked questions
Can I lose money in bonds?
Yes — by selling before maturity at a lower price, by a default, or by inflation eroding the real value. Holding a single high-quality bond to maturity removes price risk but not inflation risk.
What is duration?
A measure of sensitivity to rate changes. A duration of 7 means a 1% rise in rates costs roughly 7% of the bond’s price.
Are bonds better than savings accounts?
Not always. For money you need within a year, a savings account is simpler and safer. Bonds reward a longer horizon.
Reviewed 22 October 2026. Educational content, not financial advice. See our disclaimer.
