If equities are about owning a piece of a company, bonds are about lending money. When you buy a bond, you’re lending to a government or a corporation in exchange for regular interest payments and the return of your principal at a set date. It’s a contract: you know what you’ll earn and when you’ll get your money back (assuming the borrower doesn’t default).
What a bond is
A bond is an IOU. The issuer (a government or company) borrows money from investors and promises to:
- Pay a fixed interest rate (the “coupon”) at regular intervals.
- Return the original amount (the “principal” or “face value”) on a specific date (the “maturity date”).
For example: you buy a 10-year government bond with a 3% annual coupon and €1,000 face value. You receive €30 per year for ten years, then your €1,000 back. Predictable, boring, reliable — which is exactly the point.
The predictability is why bonds are called “fixed income”: the income is fixed in advance (unless the borrower goes bankrupt, which for government bonds of stable countries is extremely rare).
Types of fixed income
Government bonds. Issued by national governments to finance spending. Considered the safest fixed income because governments can (in theory) always raise taxes or print money to repay. German Bunds, US Treasuries, Spanish Bonos del Estado — all are government bonds with varying risk levels depending on the country’s economic stability.
Corporate bonds. Issued by companies. Higher yield than government bonds because there’s more risk the company might default. A bond from Apple carries less risk than one from a small startup — and pays less interest accordingly.
Treasury bills. Short-term government debt (usually 3-12 months). Very low return, very low risk. Used primarily for parking cash short-term.
Bond funds and ETFs. Just as with equities, you can buy funds that hold hundreds of bonds simultaneously, providing diversification and eliminating the risk of any single issuer defaulting.
The role in a portfolio
Bonds serve specific functions in a portfolio:
Stability. When equities drop 30%, bonds typically drop far less or even rise (investors fleeing to safety buy bonds). This dampens overall portfolio volatility.
Income. Regular coupon payments provide predictable cash flow, useful in retirement or when you need income from your investments.
Ballast. Bonds give you something to sell during equity crashes without locking in stock losses. They’re the part of your portfolio that lets you sleep at night.
Rebalancing fuel. When stocks crash and bonds hold steady, you can sell bonds and buy cheap stocks — systematically buying low.
The classic rule of thumb (now somewhat outdated but still directionally useful): hold your age in bonds. At 30, hold 30% bonds, 70% equities. At 60, hold 60% bonds, 40% equities. The logic: as your time horizon shortens, stability matters more than growth.
Risks of bonds
Despite being called “fixed income,” bonds aren’t risk-free:
Interest rate risk. When interest rates rise, existing bond prices fall (because new bonds offer better rates, making old ones less attractive). This doesn’t affect you if you hold to maturity — you still get your coupon and principal. But if you need to sell early, you might get less than you paid.
Inflation risk. A 3% bond in a 4% inflation environment loses real purchasing power. Your nominal return is positive, but you’re actually poorer in real terms.
Credit risk. The borrower might default. For government bonds of stable countries, this is minimal. For corporate bonds or emerging market government debt, it’s real and priced into the higher yields those bonds offer.
Reinvestment risk. When your bond matures, prevailing rates might be lower. You get your money back but can’t reinvest it at the same return.
Bonds are the counterbalance to equities. They won’t make you rich, but they’ll prevent you from panicking when markets crash. For most investors, a sensible allocation to bonds — through low-cost bond index funds — provides the portfolio stability needed to stay invested in equities through inevitable downturns. They’re the boring component that makes the exciting component bearable.
