A bond is a loan to a company or government that pays a fixed rate of return. Investors buy and sell bonds and other debt securities in the bond market. Securities are tradable assets, and debt securities include tradable debt with set terms between the borrower and lender, such as Treasury bills, notes and bonds. Bonds and debt securities vary in terms — how long you hold them — and risks.

The bond market includes new debt on the primary market and repackaged debt traded on the secondary market. So, if you don’t want to keep your bond until it matures — meaning you don’t want to hold it for its full duration or life — you can sell it early on the secondary market. But remember, there’s no guarantee that you’ll make back your original investment on the secondary market.

Loans and bond markets have existed in some form for thousands of years, dating back to ancient Mesopotamia (modern-day Iraq). The British monarchy used bonds to fund their colonization efforts, and a young U.S. government used bonds to raise funds for the Revolutionary War and again during World War I through Liberty Bonds.

The U.S. accounts for more than one-third of the world bond market,^[0]

One advantage of bonds is that they can offer a regular and immediate source of income through interest payments. Investment-grade bonds usually offer lower risks and returns than higher-risk investments like stocks.

Investing your money across a range of assets that aren’t typically affected by the same factors in the same way is a strategy called diversification. Since bonds and stocks tend to perform differently, they are used to balance each other out in financial portfolios. Adding more bonds and fewer stocks to your portfolio is a common rebalancing strategy used as people age or approach a financial goal.

Still, bonds vary in the risks they carry. They come in a range of terms from less than a year to up to 30 years. The bond issuer’s creditworthiness — be it a corporation or government — reflects its risk of default. This is known as credit risk.

Interest rates also affect bond prices, as they did in 2022. Raising interest rates to counteract inflation, as the Federal Reserve did in 2022, can push the value of bonds down. This is known as interest rate risk.

U.S. government, corporate and municipal bonds are three of the most common types of bonds you can invest in. Others include international bonds, emerging market bonds and mortgage-backed securities. The costs, risks and barriers to getting started vary by debt security.

• U.S. government bonds: Treasury bills, Treasury notes and Treasury bonds are three types of low-risk investments that offer tax advantages. U.S. Treasury bills and notes are considered the benchmark for a “risk-free” investment. Treasury bills mature in less than a year, while notes mature in two to five, and bonds in 20 or 30 years.

• Municipal bonds, or munis, fund public projects such as building bridges, roads or schools. They attract investors to their tax-free status. 

• Corporate bonds help fund U.S. corporations’ day-to-day operations and expansion. Investment-grade corporate bonds are riskier than Treasurys or municipal bonds, but still less so than stocks.

U.S. Treasury bills, notes and bonds can be purchased from the government at TreasuryDirect.gov in increments of $100. However, investing in enough single bonds to have a truly diversified portfolio across municipal, corporate and other types of bonds can be costly.

Bond index funds and exchange-traded funds (ETFs) can offer a more affordable way to invest. They are bundles of investments that mirror particular bond indexes or bond markets. Since you’re investing in a group of bonds rather than a single bond, bond funds offer immediate diversification. Remember, index funds can have high minimum investments, whereas with ETFs, you can buy for the price of a single share.

While a bond represents a loan, stocks represent an ownership stake in a company. Generally, stocks offer higher risks in return for higher rewards. The average annualized long-term return of U.S. government bonds is around 6%, whereas stocks have historically earned an average return of 10%.^[0]