What's a Bond?

This is the pilot post of a series called What's a Blank?, for the next few weeks I'll be covering some basic financial terms and how they affect us.

A lot of people are big into trading stocks, but what about bonds? They're not the most exciting security out there, but they can still play an important part in an overall investment strategy. Let me break it down Barney-style for everyone:

A bond is a formal contract to repay borrowed money with interest at fixed intervals.

This is one type of bond, but not the kind we're talking about.

Which basically means that you lend someone money, and they pay you back with interest. The "someone" in this case being a government or company. So if I buy a bond from the government, they have to pay me back not only what I paid for it, but also a little extra. There are lots of different types of bonds.

The most basic type of bond is the fixed rate bond, which pays the same level of interest over the life of the bond.

Floating rate notes have an interest rate that follows a reference rate of interest. The interest rate is recalculated every so often, typically every one or three months.

Zero coupon bonds don't pay any interest, but they sell for less than you redeem them for. An example of this is the Series E savings bonds issued by the U.S. government.

This is another type of bond, James Bond.

Inflation linked bonds have an interest rate which is tied to inflation.

That's just a smattering of the different types of bonds, but most bonds fall under one of the above categories. War bonds, for example, can be any of those four types. One reason that people generally prefer stocks over bonds is because you can generally  make a lot more money with stocks. This is due to the fact that the market rewards risk. Bonds are one of the least risky investments you can make (unless you buy junk bonds). Since they're generally issued by government or companies with good credit, you're practically guaranteed a payment (unless the government goes under, but in that case you've got a lot more to worry about). Nearly all retirement planners recommend that as a person ages they invest more in bonds, to avoid the fluctuations of the market as they near retirement.

As for my personal recommendation? I think that while bonds are nice, you shouldn't invest in them unless you have enough money that you can live off the interest they generate. This would likely place you in the million to two million range, assuming a relatively average cost of living. Until you have that much money, it's worth investing in stocks (or real estate, or whatever) until you have the money you need.

Does anyone have any experience purchasing bonds?