What does it mean when a bond appreciates?
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How do bonds work? A beginner's guide Written by Chris Butsch | Modified date: Nov. 16, 2022 A bond is money that you loan to a corporation or government in exchange for interest payments over a set period of time. Bonds are among the most underrated investment vehicles for folks under 30, offering safety, diversity, and in some cases, surprisingly high returns. Maybe you’ve heard someone shout “buy war bonds!” in a World War II flick. Or maybe you’ve overheard your folks or fellow investors talk about buying more bonds when the market is down. Either way, you probably have the general impression that bonds are: I’m here to tell you that two out of three are true; bonds are low risk and you can buy them from Uncle Sam. But they’re not that boring! In fact, they can be super smart buys for investors under 30. But how? And what exactly are bonds? How do you buy them and what kind of returns should you expect? What’s Ahead:
What is the purpose of a bond?A bond is a loan. When you buy a bond, you’re essentially loaning that money to the bond “issuer,” aka seller. In exchange, the bond issuer pays you regular interest payments. Then, when the bond “matures,” aka expires, they pay you back 100% of your initial investment amount. To use a super rudimentary example, let’s say you buy $100 worth of bonds from a corporation. That corporation will then pay you $5 every six months for 10 years, and in year 10, they pay back your full $100. Investors like bonds because they’re low risk, provide steady income, and are a nice way to diversify a portfolio. Issuers like bonds because they help them raise money for big projects like new office buildings, or in the government’s case, new bridges, roads, and other infrastructure. How do bonds work?Bonds have five key elements:
In most cases, bonds sell for the face value. When the face value equals the issue price (i.e., there are no extra fees attached), this is known as selling “at par.” How much do bonds cost?Bonds can vary in price depending on the type of bond you’re buying. I’ll be discussing the types in detail later, but here’s a quick primer on cost:
Bonds and interest ratesA bond’s interest rate is called the “coupon rate.” Why couldn’t it just be called the interest rate? Because that would be too easy! Anyways, the coupon rate is expressed as a percentage of the face value, and represents how much you’ll be paid in interest every year. For example, a $1,000 bond with a coupon rate of 4% will pay out $40 annually until the bond’s maturity date. The coupon dates are the dates on which you’ll receive those payments. So if you buy a $1,000 bond with a coupon rate of 4% and coupon dates of January 1 and July 1, you’ll receive $20 on each date until the bond expires and you get your whole $1,000 back. Do bonds have a fixed interest rate? Most bonds have a fixed interest rate, but some don’t. EE savings bonds, for example, have a fixed rate through the life of the bond. This helps you plan out your income and buy bonds accordingly. I savings bonds, by contrast, have a variable interest rate that changes every six months to match the rate of inflation. How often do bonds pay interest?In most cases, bonds pay interest every six months. But there are exceptions. I savings bonds, for example, roll your interest back into the value of the bond. So you won’t receive regular income from I bonds, but your investment will compound faster. Average bond returnThe historical average rate of return for bonds is around 5%, or half the average return of the stock market. Despite the comparatively modest returns, folks still love bonds for three reasons:
Wait, how do bonds go up in value? Do bonds increase in value?Bonds can fluctuate in value, and in some cases, they can even go up and be sold for a profit on the secondary market. Bonds tend to increase in value when:
Of course, your bond may fall in value, too. If you bought at a coupon rate of 4% — and the new coupon rate is 6% — nobody will want your bond for what you paid for it. They’ll just buy a new one. Either way, your bond’s value on the secondary market won’t impact the amount the bond issuer pays you back on the maturity date. That’s fixed. Bond exampleHere’s an example of a corporate bond you might buy:
How much will you pay upfront? And how much will you have earned from total coupon payments by the maturity date? The answers are $1,017 and approximately $240.95 respectively, not accounting for taxes and fees. Bond vs. loan: Are they the same?The key difference between a bond and a traditional loan is the timing of the principal payment. With bonds, the issuer holds onto 100% of the principal until the day the bond matures. With traditional loans, the principal and interest are paid back simultaneously. In other words, the payments on a five-year, $1,000 loan might look like this:
Whereas the payment schedule for a five-year, $1,000 bond might look like this:
Types of bondsWhat are the three main types of bonds, and which is best for investors under 30? Treasury bonds
When you buy U.S. Treasury bonds, you’re loaning money directly to the U.S. government. In exchange, you get the lowest possible risk out of any bond investment (or investment in general). Treasury bonds are also the only bonds you can buy without going through a broker. It’s super safe and easy through TreasuryDirect.gov. Plus, Treasury bonds are surprisingly neat and quirky. EE savings bonds are guaranteed to double in value after 20 years (making them great college graduation gifts for the infants in your family). I bonds match the rate of inflation, so as of this writing they’re selling at an eye-watering 9.62%. Municipal bonds
Municipal bonds, aka “munis,” are bonds issued by a city and are typically used to fund big infrastructure projects like roads, bridges, libraries, and schools. Munis tend to be higher interest than Treasury bonds but lower risk than corporate bonds. Plus, you get the warm fuzzies knowing you directly supported a city’s growth and welfare. Trouble is, munis are typically sold in increments of $5,000, pricing out most investors, and you have to buy them through a broker. Still, they’re a possibility on the table if you’re a high-cap investor looking to support your local municipality. Corporate bonds
Finally, corporate bonds are issued by — you guessed it — corporations. Typically these are big companies looking to quickly fund big projects, so corporate bonds tend to have quicker maturation dates (2, 3, 5 years) compared to government-issue bonds (10, 20 years). Corporate bonds also tend to fluctuate more in value on the secondary market since the reputation of the company can change on the daily. If investors get spooked that a company might default, its stock price and its bond values may plummet. In short, corporate bonds are the “high risk, high reward” choice of the bond world. Pros and cons of bondsAdvantages of bonds
Disadvantages of bonds
Are bonds a good investment?Bonds are a great buy when:
Buying bonds might not be the move if:
How to buy bondsI wrote a whole beginner’s guide on how to buy bonds, but here’s the CliffsNotes version:
I strongly recommend connecting with a financial advisor to help you research the right bonds. Plus, it’s just good to have an FA on your side. SummaryBonds are pretty underrated investments for folks under 30. While some may be complex to buy, bonds can generate passive income, rebalance the risk in your portfolio, and even help you hedge your savings against inflation. Featured image: Shutterstock/larry1235 Read more:
#SubscribeSave Your First - Or NEXT - $100,000 Sign Up for free weekly money tips to help you earn and save more We commit to never sharing or selling your personal information. About the authorTotal Articles: 197 Chris ButschTotal Articles: 197 Chris helps people under 30 prosper - both financially and emotionally. In addition to publishing personal finance advice, Chris speaks on the topics of positive psychology and leadership. For speaking inquiries, check out his CAMPUSPEAK page, connect with him on Instagram, or watch his TEDx talk. Read more from this author
Editor’s Note:You can trust the integrity of our balanced, independent financial advice. We may, however, receive compensation from the issuers of some products mentioned in this article. Opinions are the author's alone. This content has not been provided by, reviewed, approved or endorsed by any advertiser, unless otherwise noted below. What does it mean when a value appreciates?Appreciation, in general terms, is an increase in the value of an asset over time. The increase can occur for a number of reasons, including increased demand or weakening supply, or as a result of changes in inflation or interest rates. This is the opposite of depreciation, which is a decrease in value over time.
What does appreciation mean in investing?Appreciation means that the value of a financial asset increases over time. This increase occurs for many different reasons, including increased demand, weakened supply, or a change in inflation or interest rates.
What is an example of an appreciating asset?Appreciation is used to refer to any asset that increases in value. That includes equity, bonds, real estate, and currencies. The term capital appreciation is often used when referring to financial assets that increase in value. Most traditional portfolios will contain a good portion of assets like this.
How does appreciation affect investment?An exchange rate depreciation (appreciation) stimulates (dampens) investment by enhancing demands in both the domestic and export markets, but it reduces (increases) investment because of the increasing cost of imported intermediate goods and the user cost of capital.
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