Bonds
A bond is a loan to a government or company that pays a fixed coupon and returns the principal at maturity. The coupon does not change, but the price does — and it moves opposite to interest rates, which is how a holding that pays reliably can still show a loss.
A bond is the simplest financial contract there is: you lend, they pay interest on a schedule, they return the principal on a date. Everything difficult about bonds comes from what happens if you do not hold it to that date.
How it works
You lend a fixed amount and receive a fixed coupon, usually twice a year, until the maturity date when the principal comes back.
The coupon is set at issue and never changes. That fixedness is the appeal and it is also the source of every price movement the bond will ever have.
If new bonds start paying more, yours is worth less, because nobody will pay full price for a smaller coupon. If new bonds pay less, yours is worth more. The coupon did not move; the competition did.
A worked example
Take a bond paying a 3% coupon on 1,000, so 30 a year.
If prevailing rates rise to 5%, a new buyer can get 50 a year for the same 1,000.
So your bond has to be discounted for its 30 to compete — roughly to 600 on a perpetual bond, and less severely the closer it is to maturity, because the principal is coming back soon regardless.
Which is why maturity length is the main lever on how violently a bond price moves. A one-year bond barely reacts; a thirty-year bond reacts enormously to the same change in rates.
And if you hold to maturity, none of it matters. You receive every coupon and the principal, and the price in between was a quote you never acted on.
Bonds against bond funds
A bond fund holds many bonds and continuously replaces the ones that mature, so it has an average maturity but no maturity date of its own.
That removes the escape hatch. With an individual bond, waiting resolves a price fall; with a fund, there is nothing to wait for — the fall is realised in the unit price and recovers only if rates move back.
The compensation is diversification and convenience. A single issuer defaulting is survivable in a fund and can be serious in a portfolio of three bonds.
The two risks
Interest rate risk is the price effect described above, and it applies to every bond including government ones. It is not a judgement about the issuer.
Credit risk is the chance the issuer does not pay. A government borrowing in its own currency and a company with heavy debt sit at opposite ends of that, and the extra yield offered by the second is the market’s price for the difference.
Higher yield is compensation for one of those two, and it is worth knowing which before buying.
Tax and where to hold them
Coupon payments are generally taxed as ordinary income rather than at the lower rates sometimes applied to dividends or long-term gains. Treatment varies by jurisdiction and this is educational, not tax advice.
Which is why bonds often sit inside a tax-sheltered account when a portfolio has both kinds available, and equities sit outside it.
Costs
Individual bonds trade over the counter and the spread is wide, particularly in small sizes. On
this site’s shared series a round trip measures about 2% of the median bar range of 0.493 — and a
retail-sized corporate bond order is typically worse than that. The figures are in
research/series-measurements.json.
A broad bond fund’s fee is often smaller than the spread you would pay buying individual bonds, which is a real argument for the fund beyond diversification.
The original data
Of the 24,971 unique videos in research/search-study-corpus.jsonl, only 2 have a title about
buying bonds, at a median of 87,102 views — and 100% of them use beginner-shaped language. Every
single video on the subject is introductory. Index funds appear in 132 at 69,951 and dividend
investing in 194 at 7,535. The counts come from site/rank_investing.py.
Two videos, both for beginners, at 87,102 median views. Bonds are roughly half of a conventional portfolio and have essentially no instructional coverage in a corpus of 24,971 finance videos, which is the largest coverage gap measured on this site.
The answer to the question on that chart is that the fund’s yield rose by exactly the amount that caused the fall. The holdings now pay more than they did, and the loss is the price of that repricing having happened all at once. Selling converts a paper fall into a realised one and hands the higher yield to the buyer — which is the specific mistake a rising-rate year produces most often.
When it fails
A bond fund in a sustained rising-rate period is the case that defeats people, and it defeats them by behaving exactly as designed. The unit price falls, the statement shows a loss on the safe part of the portfolio, and there is no maturity date to wait for. Every instinct built from holding individual bonds — that waiting resolves it — is wrong for a fund, and the money most often leaves at the point where the yield has finally become attractive.
The second failure is buying yield without asking which risk it is paying for. Rate risk and credit risk are not interchangeable.
A third is holding long-maturity bonds for stability. Long bonds are volatile.
A fourth is buying individual corporate bonds in small sizes. The spread is punishing.
A fifth is holding them in a taxable account by default. Coupons are usually ordinary income.
And a sixth is expecting them to produce returns. In most portfolios they are there to behave differently from equities, not to compete with them.
Related
Treasury bills are the very short end of the same market. Asset allocation is why a portfolio holds any at all. And index funds is the equity side they are usually paired against.
The distinction that took me longest to internalise is between an individual bond and a bond fund. Hold a bond to maturity and the price swings in between are noise you can ignore. Hold a fund and there is no maturity date at all — the swings are the whole experience, and a rising-rate year shows up as a loss you cannot wait out the same way.
— Michael Whitman
This page is educational, not financial advice. Test every idea on your own charts before risking money.