Educational information, not individual financial advice.
Key Takeaways
A bond is a loan. When you buy a $1,000 Treasury bond with a 4% coupon and 10-year maturity, you are lending the U.S. government $1,000. In return, the government pays you $40 per year for 10 years and returns your $1,000 at maturity.
Bonds are the second major pillar of most portfolios. They sacrifice long-run return for much lower volatility — an essential trade-off as retirement approaches.
If you hold a bond to maturity, its price fluctuations don't matter — you get coupon payments plus face value back, period. But if you sell before maturity, price matters, and bond prices respond to two main forces:
Interest rate changes. Bond prices move inversely to interest rates. If you own a 3% bond and new bonds are issued at 5%, your 3% bond is less attractive — its price must fall until the effective yield equals 5%. Longer-maturity bonds are more sensitive; a 30-year bond's price moves far more for a 1% rate change than a 2-year bond.
Credit quality changes. If the issuer's financial position deteriorates, the bond's perceived default risk increases and its price falls.
The 2022 bond market decline — the worst in decades — was driven by rapid interest-rate increases by the Federal Reserve, which pushed existing bond prices down across the board.
U.S. Treasuries — bonds issued by the federal government. Essentially no default risk; fully backed. Interest is exempt from state and local tax. This is the benchmark for "risk-free" rates.
Municipal bonds — issued by state and local governments. Interest is generally exempt from federal income tax and often from state tax if you live in the issuing state. Useful for high-income investors.
Corporate bonds — issued by companies. Higher yields than Treasuries but with credit risk. Investment-grade is relatively safe; junk/high-yield compensates for real default risk.
TIPS (Treasury Inflation-Protected Securities) — principal adjusts with CPI, so real returns are locked in. Useful for inflation hedging and retirement spending.
I-Bonds — government savings bonds whose rate is adjusted for inflation twice a year. Annual purchase limit is $10,000 per person, which restricts them to niche use.
For most investors, a bond fund is the right choice. A broad index like the Aggregate Bond Index holds thousands of bonds across types and maturities, rebalancing constantly. You get predictable interest payments and diversification without managing individual maturities.
Individual bonds make sense for specific use cases: a bond ladder for a known spending need (college tuition in 10 years), a Treasury to lock in a specific rate, or when you want precise duration control.
Duration is a measure of how much a bond (or bond fund) price will change for a 1% change in interest rates. A bond with a duration of 7 will lose about 7% of its value if rates rise 1%, and gain about 7% if rates fall 1%.
Short-duration funds (1–3 year average maturity) have duration around 2 and are relatively insensitive to rate changes. Long-duration funds (20+ years) have duration around 15 and swing dramatically on rate news.
Bonds do three jobs in a portfolio:
The third role has been less reliable recently — in 2022, stocks and bonds fell together as rates rose. That was an unusual environment.
Bond-heavy portfolios are classified as "conservative" in Horizons, with lower expected return and lower volatility. Allocation schedules typically move toward more bonds as retirement approaches, reducing sequence risk but also reducing long-run growth.
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