How Bonds Make (and Lose) Money

Bonds are generally considered less risky than stocks for a number of reasons, but they aren’t a risk-free place to invest your money. When you own an individual bond, you generally have two choices: You can buy it and hold it until it matures, or you can sell it for a profit (or a loss). Sometimes investors decide to sell a bond before it matures. Perhaps they’ve found a better place to put their investment, or maybe they simply want (or need) to get their money. In this case, they may have to take a loss if they can’t find a buyer willing to pay face value to buy the bond. 

Of course, this process also works in reverse. If enough people want to buy your bond—because its coupon rate is higher than prevailing rates on similar types of bonds—you can sell it for more than its face value and collect a profit. This sort of active trading approach to bonds can be risky, however, and is best left to the experts. If you follow the news from the bond market, you’ll probably hear a lot of talk about how the “yields” on various types of bonds are changing from day to day. 

The current yield is simply a way to express as a percentage the interest rate a bond would actually pay if you bought it at the current market price, as opposed to the coupon rate it offered people who bought it at face value when it was first issued. As an example, take a $1,000 bond with a coupon rate of five percent. No matter what price it trades for, it will still pay five percent of its original value, or $50 in interest a year. If, for any reason, demand for that bond increases to the point where people are paying $1,100 for it, those people would receive a current yield of that $50 interest payment divided by the current market price ($1,100), or about 4.5 percent.