INVESTING ESSENTIALS
Bonds are complex loans influenced by interest rates.
Bonds are considered less risky investments because most bonds aim to pay interest and return the principal investment.
A bond is simply a loan from an investor to a corporation or a government entity. It has a defined maturity date, the investor will collect interest payments and if money is kept in the bond through the maturity date, the investor will get the full investment back. Corporate entities use money raised with bonds to fund ongoing operations (e.g., technology upgrades or business expansion). The federal government, states and cities issue bonds to raise money to fund projects that benefit the community (e.g., to build roads or improve a local school).
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When a bond is available for purchase, investors look for the following details:
Issuer
The issuer is the name of the entity issuing the bond. The issuer receives the money you pay for the initial bond purchase. Some of the most common issuers may be a corporation, municipality, state 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. Federal government bonds, also known as U.S. Treasuries, have maturity date ranges: less than one year for bills; one year to 10 years for notes; and as long as 30 years for bonds. Corporate bonds have maturity date ranges: generally three years or less for short term; four-10 years for intermediate; and 10+ 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 held to maturity. As a hypothetical example, a $100 bond that has a coupon of 5%, or $5, would have a yield of 5% ($5 divided by the $100 purchase equals 5% yield). If you purchase the same bond for $110 in the market, the $5 coupon would result in a yield below 5% because the bond was purchased at a premium ($5 divided by the $110 purchase equals 4.54% yield). If you purchase the same bond for $90, the $5 coupon would result in a yield above 5% since the bond was purchased at a discount ($5 divided by the $90 purchase equals 5.5% yield).
Bond rating
Bond ratings (also known as credit ratings) are similar to grades and allow you to quickly see the risk of the organization issuing the bond. Credit rating services such as Moody’s Investor Services and Standard & Poor’s® provide bond ratings based on the perceived likelihood of the bond issuer being able to pay you back. Bonds issued by the U.S. government are considered very safe and virtually risk-free.
On the other end of the risk spectrum are bonds issued by corporations with a low credit rating, and are referred to as high yield or junk bonds. While they can offer a higher coupon rate, they also carry higher risk. Corporations may have a lower credit rating for several reasons including a spotty financial record, small size, risky business model or a high amount of debt.
A common type of bond is a U.S. Treasury note (T-note). As a hypothetical example, a T-note might have a face value of $10,000, a maturity of five years, and a coupon rate of 2%. If you own this bond, you’ll receive $200 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 2%. It may look pretty straightforward, but when we bring changing interest rates into the picture, things get a little more complex.
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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 a hypothetical 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%. This can mean that interest rates were lower a year ago. 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, market values go down, which in turn cause yields to go up. This price movement is what makes the bond market so dynamic.
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). Bond funds may have varying ratings, sectors exposure 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.
Thrivent offers a wide variety of bond mutual fund 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 in 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.
