Although you don’t hear about bonds as much as you do stocks, bonds are actually a bigger part of the overall market. In the U.S. alone, over $5.4 trillion dollars in bonds were issued in 2014 and the total debt outstanding on U.S. bonds was nearly $39 trillion by the end of 2014.1
What is a Bond?
The Federal government, states and cities issue bonds in order to raise money for a variety of reasons. When you buy a bond, you’re essentially loaning money that will be paid back in a set amount of time, with interest. Governmental agencies use money raised with bonds to fund projects that benefit the community (e.g., to build roads or improve a local school). Corporate entities use money raised with bonds to fund ongoing operations (e.g., technology upgrades or business expansion).
Parts of a Bond
When a bond is available for purchase, these are some of the key things investors look for:
The issuer is the name of entity issuing the bond. The issuer receives the money you pay in the initial bond purchase. Some of the most common issuers may be a corporation, municipality, or the federal government.
- Face Value
The amount of money to be paid to the owner of the bond on the maturity date is the face value.
- Maturity Date
The maturity date is the date in which the issuer must pay back the face value of the bond to you. Government bonds have two maturity dates: less than one year for “bills”; and as long as 30 years for bonds. Corporate bonds have three maturity dates: generally, 5 years or less for short term; 5-12 years for intermediate; and 12 years + for long term.
- Market Value
The purchase price of a bond, which may be different than its face value, is the market value. When the market value of a bond matches its face value, it’s considered “on par.” If the market value dips below the face value, the bond is a discounted bond. When a bond’s market value exceeds its face value, it’s a premium bond.
- Coupon Rate
The coupon rate is the rate used to calculate the interest paid by the issuer to you (the bond owner) for use of your money. Interest is paid to you on a predetermined schedule depending on the bond’s maturity date.
- Bond Yield
The bond yield is the amount of return on investment you’ll get on a bond. It’s calculated by the market value of the bond, divided by the yearly interest paid. As an example, a $100 bond that has a rate of 5% would yield $5 on an annual basis. A more complicated variation of bond yield is “Yield to Maturity,” which factors in the bond’s maturity.
- Bond Rating
Bond ratings (also known as credit ratings) are a bit like grades, and allow you to quickly see what kind of risk the organization issuing the bond might be. Credit rating services such as Moody’s Investor Services and Standard & Poor’s provide bond rating scores based on the perceived likelihood of the bond issuer being able to pay you back. Bonds issued by the U.S. government are considered risk-free. On the other end of the risk spectrum are high yield bonds also referred to as “junk bonds.” They’re mostly issued by corporations with spotty financial track records. Higher risk bonds typically offer higher rates.
A common type of bond is a U.S. Treasury note (T-note). As an example, a T-note might have a face value of $10,000, a maturity of five years, and a coupon rate of 6%. If you own this bond, you’ll receive $600 a year for five years. When this T-note matures, you’ll receive the face value of $10,000. The bond’s yield stays at a steady 6%. Seems pretty straightforward, but here’s where bonds get complex.
The Impact of Interest Rates
Bonds can be bought and sold during the span of their maturity. The face value of a bond doesn’t necessarily reflect its market value. Major players in the bond market like the U.S. Treasury are issuing new bonds as older ones mature. These new bonds reflect the interest rate when they’re issued. For example, a new $10,000 T-note bond may have a coupon rate of 8% instead of bonds issued, let’s say, a year ago at 6%. A $10,000 T-note with a 6% coupon rate has less value to investors than one with an 8% coupon rate, and its market price may drop from $10,000 to $9,000. In turn, its bond yield increased from 6% to 6.6%. So when interest rates go up, bond prices go down, which in turn cause yields to go up. This price movement is what makes the bond market so dynamic.
Bonds in Mutual Funds
Bond mutual funds can be comprised largely of one type of bond (e.g., municipal bonds) or a combination of bond types (e.g., corporate and government bonds). The bond funds may have varying ratings, sectors, and maturities. This diversification of bonds can help mitigate, but not eliminate, the volatility of the mutual fund.
Generally, bonds are considered less risky than stocks. This is because most bonds aim to pay interest and return the principal investment. Due to the complexity of bonds, and that bonds are typically purchased in large lots, most investors of bonds are institutional.
What Thrivent Mutual Funds Offers
Bond mutual funds with Thrivent Mutual Funds offer a wide variety of options. Some are focused on generating high levels of income and invest in higher risk bonds as a way to try to achieve this. Some funds are focused on adding diversification to help mitigate risk of an overall investment portfolio.
When you choose to invest with Thrivent Mutual Funds, you’ll benefit from the expertise of our investment professionals and the convenience and choices we provide to make investing easier. So go ahead and explore the options. You may be funding the next great American innovation.
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