FBLA Financial Literacy Initiative

What is a Bond and How Does it Affect You?

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When looking at potential investments, we generally know what stocks are and how they work. Based upon investor sentiment and quarterly earnings calls, stocks will rise and fall based on their outlook. One type of investment that is generally overlooked is a bond. This could be largely because bonds do not carry the allure that stocks may carry; investing in stocks is often a day-to-day activity and investors need to make decisions quickly. However, although bonds may have less “action,” they are nonetheless a relatively easy way to grow money quietly and easily over time.

To start off, what exactly is a bond? It is not really an investment in the sense that money is deposited into an account and it grows over time. Essentially, when you “purchase” a bond, you become a lender to the government. Whether you are a lender to the local, state, or federal government depends on the type of bond you buy. By buying a bond, you are essentially a “mini-bank.” When you cash in the bond, you will get more money than you initially paid the government.

Let’s delve into the terminology. The price at which you buy the bond is known as the face value, sometimes abbreviated FV. Most calculations are done based upon the face value. One such calculation is called the interest, which is where the interest rate (a number between 0 and 1) is multiplied by the face value and time. This interest is also known as the bond’s yield. Lastly, the sum of the face value and the yield is called the maturity value and this is what the government pays back in a lump sum on the maturity date, when the bond is “due.”

So, why exactly is it worth it to invest in a bond? Although, according to Marketwatch, bonds are meant to be boring, they are not the type of investment that you can ignore. The only risk that is present is if the yield happens to be negative at a certain point in time. Other than that, bonds tend to grow steadily in value over time and are more robust against investor sentiment. For example, stocks are particularly volatile in the months of December, March, June, and September because companies release quarterly earnings reports. Even a small earnings miss can send the stock plummeting, and with it, your net worth. Bonds, on the other hand, will not have a negative yield unless the economy is in the throes of recession or depression. One particular approach that top investors embrace is the 60/40 approach, where 60 percent of savings is invested in stocks and 40% in bonds. This is mainly so that these investors can allow their portfolios to remain stable in times of economic turmoil. Next time you have a hundred dollars and want to invest it, consider a boring low-risk bond rather than an exciting high-risk share of stock.

-Varun Kumar

2017-18 FBLA National Treasurer’s Council Member

 

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