How to invest in bonds: A basic guide

If you're looking for a steadier way to grow your savings without riding out every swing in the stock market, bonds are worth a closer look. Getting started is more approachable than it might seem. A bond is essentially a loan: you lend money to a government or company, and in return, you receive regular interest payments plus your original investment back at a set date.

Bonds are one of several investment options to consider alongside stocks, real estate, mutual funds, exchange traded funds (ETFs) and certificates of deposit (CDs). Historically, bonds have been a means to pursue long-term goals while bringing some balance to a portfolio that includes riskier investments.

This guide covers what bonds are, how they work and the practical steps for investing in them.

Bonds are debt contracts that governments and companies use to raise money. When you buy a bond, you're the lender. The issuer agrees to pay you back, with interest, by a set date. Unlike stockholders, you don't hold an ownership stake in the company or benefit from its growth beyond the interest you're owed.

This structure is part of why bonds are generally considered more conservative. Interest rates are fixed and payments typically arrive once or twice a year, which makes the income predictable. Default risk also tends to be low. Government bonds in particular carry the full faith and credit of the issuing government, making them more reliable than many other investments, though not risk-free.

A few terms in relationship to bonds come up often enough that it's worth knowing them upfront:

• Issuer: The government or company borrowing the money.
• Face value (or par value): The amount the issuer borrows and must repay at maturity, commonly $1,000 for individual bonds.
• Coupon rate: The fixed interest rate stated in the bond contract.
• Maturity: The date the issuer repays your principal in full.
• Yield: What the bond actually pays relative to what you paid for it. More on this below, since it's easiest to understand with a real example.

Say you buy a $1,000 bond with a 5% coupon rate. You'll receive $50 a year in interest (usually split into two $25 payments), and at maturity, you get your original $1,000 back. That's the simplest version.

A bond's price can move up or down on the secondary market, based on interest rates and the issuer's creditworthiness. Say you bought that same bond for $950 instead of $1,000. Your $50 in annual interest now represents a slightly higher yield, because you paid less to receive the same payment. That's the core relationship between price and yield in bond investing—when bond prices fall, yields rise, and vice versa.

You're not required to hold a bond until it matures; you can sell it on the secondary market, though you may get more or less than you paid, and you'll stop receiving interest once you sell.

Some bonds are callable, meaning the issuer can redeem them early, usually at a higher rate to compensate for that uncertainty. Others are zero-coupon: they pay no regular interest but sell at a discount, so the "interest" is the gap between your purchase price and the face value you receive at maturity.

If you hold a bond to maturity, the issuer repays your principal plus any final interest due. If the issuer defaults, what happens next depends on whether the bond is secured (backed by collateral you can claim) or unsecured (which may require legal action to recover anything).

There are four main paths into bond investing, and you don't have to pick just one.

1. Open a brokerage account. Most individual bonds—corporate, municipal and some Treasury—are bought through a brokerage account. You can purchase newly issued bonds or buy existing bonds from other investors on the secondary market.
2. Buy directly from the U.S. Treasury. TreasuryDirect lets you buy Treasury bonds, notes, bills, TIPS and I bonds straight from the federal government, without a broker or added fees.
3. Invest in a bond mutual fund. A bond fund pools your money with other investors to buy a diversified mix of bonds, managed by a professional fund manager. This is often the simplest way to get broad exposure without researching individual issuers.
4. Invest in a bond ETF. Bond ETFs work similarly to bond funds but trade on an exchange throughout the day, like a stock. They typically have lower minimums than buying individual bonds outright. Thrivent offers its own bond ETFs and mutual funds if you'd rather invest in bonds through a fund than build a position bond by bond.

If you're not sure where to start, bond funds and ETFs tend to be the more approachable entry point. You get diversification across many issuers without needing to evaluate each one individually. Individual bonds make more sense once you have a specific goal in mind, like matching a bond's maturity date to a known future expense.

Bond features vary depending on who issues them and how they're structured. The three main categories are treasury, corporate and municipal bonds, each with different risk, yield and tax profiles. You'll find all three available either as individual bonds or bundled inside bond funds.

Treasury bonds

The U.S. Treasury Department issues these to fund the federal government, and they're widely regarded as the safest bonds available because the government can ensure payment. That safety comes with a tradeoff: interest rates tend to be lower than other bond types.

The Treasury offers several variations:

• Treasury bonds mature in 10 to 30 years.
• Treasury notes mature in two to 10 years.
• Treasury bills (T-bills) mature in 12 months or less, paying interest as a lump sum at the end.
• Floating rate notes carry a two-year term with a variable rate paid quarterly.
• Treasury Inflation-Protected Securities (TIPS) adjust payments to keep pace with inflation.

One advantage worth noting: interest from federal bonds is exempt from state and local income tax, which is especially valuable if you live somewhere with a high state tax rate.

Corporate bonds

Companies issue bonds to fund operations, projects, research or equipment. Most pay interest every six months, and that interest is taxed at both the state and federal level.

Municipal bonds

Municipal bonds are issued by state and local governments, and their defining feature is tax treatment: interest is typically exempt from federal tax, and from state tax, too, if you live in the issuing state. That makes them especially attractive for investors in higher tax brackets. Even though their stated interest rates are lower, the after-tax return can end up higher than a comparable taxable bond.

Neither option is universally better. Choosing between individual bonds and bond funds depends on how much control you want, how much capital you're starting with and what you're investing toward.

The key distinction is that an individual bond has a defined endpoint. If you hold it to maturity, you know exactly what you'll get back.

A bond fund never matures; its value moves with the market for as long as you hold it. That's not necessarily a reason to avoid funds. Many investors end up using both—funds for broad diversification, individual Treasury bonds for a specific, time-bound goal.

Part of what makes bonds a relatively reliable investment is that issuers receive credit ratings from independent agencies, signaling how likely they are to repay what they owe. Higher ratings generally mean a safer investment and a lower interest rate, since less risk requires less compensation to attract investors; lower-rated bonds pay more to make up for the added risk.

Bonds rated "BBB-" or higher (S&P Global, Fitch) or "Baa3" or higher (Moody's) are considered investment grade, with lower default risk. Anything below that is labeled high-yield, or "junk." These bonds can be tempting for the higher payout, but they carry a meaningfully greater chance of default.

Bonds tend to make the most sense if you're looking for steady income, or if you want to balance out the volatility of stocks elsewhere in your portfolio. A few questions can help you figure out where they fit for you:

• What's your timeline? Money you'll need in the next few years generally calls for shorter-term, lower-risk bonds. Longer horizons give you more flexibility to consider a broader range of options.
• Do you need income now, or are you investing for the future? Bonds that pay regular interest can support current income needs. If you're not drawing on the money yet, that interest can be reinvested.
• How do you feel about price swings along the way? If holding to maturity is your plan, day-to-day price movement matters less. If you might need to sell early, it matters more.

One practical strategy worth knowing is a bond ladder. Instead of putting everything into bonds that mature at the same time, you spread your investment across bonds with staggered maturity dates.

For example, you might own one bond maturing each year for the next five years. As each bond matures, you reinvest it or use the proceeds, which gives you regular access to your money and helps smooth out the impact of changing interest rates over time.

That said, bonds aren't without risk:

• Interest rate risk. When rates rise, existing bond prices fall. This matters less if you're holding to maturity, but more if you might sell beforehand.
• Inflation risk. Fixed coupon payments are great for stability, but inflation erodes the real value of that income over time.
• Default risk. If an issuer can't meet its obligations, you may not receive interest, or you could even lose your principal. This risk is lower for higher-rated issuers, and you can further manage it by diversifying across multiple issuers and bond types.

Whether you're ready to start investing in bonds or still weighing how they fit into your bigger picture, a Thrivent financial advisor can help. They'll get to know your goals, timeline and risk tolerance, and help you figure out how—and how much—bonds should factor into your overall plan.