Investing Fundamentals: How to Invest in Bonds

A bond is a loan to an organization that is looking to raise a sum of money to pay for certain projects. These can include corporations and governments at the federal, state and local levels. For example, governments often issue bonds to finance infrastructure projects like building roads, schools and parks. 

Bonds are a type of fixed-income investment because they provide a predictable income stream in the form of interest payments throughout a specified period of time. There are many different types of bonds, but the basic categories are U.S. Treasury bonds, municipal bonds, and corporate bonds. 

How do bonds work?

Companies and governments issue bonds when they need to borrow money. When you purchase a bond, you are giving a loan to the issuer (borrower). 

Investing in a bond comes with a specific set of borrowing terms; the borrower promises to pay you back for the original sum of the loan (principal or face value) by a certain date (maturity date). 

In addition, you will also receive regular interest payments from the borrower. The interest payments are usually set at a fixed, pre-determined rate (coupon rate). But there are bonds with variable interest rates, and as the name implies, this means the interest rate will go up or down over time. 

Let’s look at a basic example: If you buy a 10-year bond at the face value of $1,000 with a fixed 5% coupon rate, you will receive a total of $50 in interest payments ($1,000 x .05 = $50) every year until the bond “matures” or comes due. The frequency of payment can be either semiannual ($25 every six months) or annual. When the bond is due in 10 years, you will get back the original $1,000 you invested. 

Where can you buy bonds?

There are three main ways to buy bonds:

U.S. Department of the Treasury: You can purchase a variety of U.S. government bonds directly from the
United States Treasury (via Treasury Direct) with no maintenance fees

Brokerage Firm: You have the option of purchasing Treasury bonds as well as other types of bonds, such as corporate bonds and municipal bonds 

Mutual Funds and Exchange Traded Funds: Buying bonds can be expensive because many bonds have high minimum purchase requirements. This is when buying bonds through a mutual fund or an exchange-traded fund (bond ETFs) may be helpful. These funds can give you access to a diversified pool of bonds at a low cost

Why invest in bonds?

Bonds can offer three main benefits:

A steady flow of interest income: Bonds make interest payments at a fixed rate

Stability during a volatile market: Fixed-income investments, like bonds, are typically protected from the volatility of the stock markets

Potential tax savings: Some bonds, like municipal bonds, can even provide tax-free earnings.

We encourage you to reach out to your Goldman Sachs team if you have any questions.