How Bonds Work
When a government or company needs to raise money, one option is to borrow from investors by issuing bonds. As the investor, you lend a set amount (the face value or principal). In return, you receive regular interest payments — called the coupon — typically semi-annually or annually. At the end of the bond's term (maturity), you get your principal back.
Example: you buy a 10-year US Treasury bond with a face value of $1,000 and a 4.5% annual coupon. Each year you receive $45 in interest. After 10 years, you receive your $1,000 back. Total income: $450 over 10 years, plus your original investment returned.
Bonds can also be bought and sold on secondary markets before maturity, which is where price fluctuations come in.
Types of Bonds
| Bond Type | Issued By | Risk Level | Typical Yield |
|---|---|---|---|
| Government (Sovereign) | National governments | Very low (stable economies) | 4–5% (US/UK 2026) |
| Investment-Grade Corporate | Large, stable companies | Low to moderate | 5–6% |
| High-Yield (Junk) Bonds | Higher-risk companies | High | 7–10%+ |
| Municipal Bonds | US local governments | Low | 3–4% (often tax-exempt) |
| Inflation-Linked | Governments (TIPS, index-linked) | Low | Adjusts with inflation |
Yields as of May 2026. Actual yields vary with market conditions and bond duration.
Why Bond Prices Fall When Rates Rise
This confuses a lot of people, so it's worth explaining carefully.
Say you hold a bond paying 3% interest when the central bank raises rates and new bonds start paying 5%. Suddenly your 3% bond looks unattractive compared to new ones. To sell it, you'd have to lower the price. Conversely, if rates fall, your 3% bond becomes more desirable than new ones paying 2%, so its price rises.
This is the core risk of bonds: interest rate risk. If you hold a bond to maturity, price fluctuations don't affect you — you get your principal back regardless. But if you need to sell before maturity, you might get less than you paid if rates have risen.
In 2022, the Bloomberg US Aggregate Bond Index fell approximately 13% — its worst year in decades — as the Federal Reserve raised rates rapidly from near zero to over 5%. This illustrated that bonds are not risk-free, particularly in rising rate environments.
Bonds vs Stocks
Stocks represent ownership in a company. Their value is tied to the company's growth and profitability. Bonds represent debt — you're a creditor, not an owner. This difference has practical consequences.
Bonds are generally less volatile. They don't double in a good year, but they also don't crash 40% in a bad one. Historically, when stock markets fall sharply, high-quality government bonds often rise (investors flee to safety), providing a natural counterbalance in a mixed portfolio.
Over the long run, stocks have outperformed bonds significantly. The trade-off is volatility — bonds smooth out the ride in exchange for lower expected returns.
When Should You Own Bonds?
For young investors with 20–30 year horizons, a heavy bond allocation typically reduces long-term returns without providing much benefit. Most financial planners suggest a small or zero bond allocation for investors in their 20s and 30s.
As you approach retirement, bonds become more important. A 60/40 portfolio (60% stocks, 40% bonds) is a classic allocation for investors nearing or in retirement. The bonds reduce volatility and provide income, even if they drag down peak returns.
A simple rule of thumb: your bond percentage might equal your age minus 10 or 20, depending on your risk tolerance. A 50-year-old might hold 30–40% bonds. A 30-year-old might hold 10% or none at all.
How to Buy Bonds
The easiest way for most investors is a bond index fund — it holds thousands of bonds in a single purchase, is instantly diversified, and costs almost nothing to own. Vanguard's BND (Total Bond Market ETF) and VBTLX (mutual fund equivalent) are the most commonly used in the US, with expense ratios of 0.03%–0.05%.
You can also buy individual government bonds directly. US investors can purchase Treasury bonds commission-free at TreasuryDirect.gov. This eliminates fund fees but requires more management.
Bonds in the UK, India, and Canada
UK (Gilts): UK government bonds are called gilts. They can be bought through a stockbroker or via a bond fund in an ISA. The iShares Core UK Gilts ETF (IGLT) and Vanguard UK Government Bond Index Fund are popular options. Index-linked gilts adjust with inflation and are popular among retirees.
India (Government Securities / G-Secs): Indian government bonds are called G-Secs or Government Securities. The RBI Retail Direct scheme allows individual investors to buy them directly at rbiretaildirect.org.in without a broker. Bharat Bond ETFs, listed on NSE and BSE, offer a fund-based approach. Sovereign Gold Bonds (SGBs) are another government-issued option with gold-linked returns plus 2.5% annual interest.
Canada: Canadian government bonds (federal and provincial) can be purchased through a brokerage. The iShares Core Canadian Universe Bond ETF (XBB) and Vanguard Canadian Aggregate Bond ETF (VAB) are the most common fund options, available inside a TFSA or RRSP.