Governments and large companies collect fund from public market by issuing bonds. While government may need money for social programs or infrastructure, companies use them to fund expansion.

Such funds are too large to be provided by a single bank or financial institution. As such, thousands of investors in public market come together to lend portion of the capital needed.

Thus bonds are different from equities. Buying equities entitles you to be an owner of the company but in case of buying a bond makes you a lender.

So why would you lend your money? There are many reasons for buying bonds. First and foremost – it gives fixed income for fixed period. Bonds promise to give you fixed return in form of interest payment.

Rate of interest, referred to as “coupon rate” and date of maturity is decided while investing in bond. The amount borrowed by issuer (government or company) is called “face value” of the bond. To simplify the jargons let us consider an example.

You buy a bond with face value of $1000 at coupon rate of 7% and maturity of 10 years. This means you will receive $70 of interest per year for next 10 years. After 10 years you will get back your $1000.

This brings us to the second most attractive feature of bond investment – preservation of capital over a period of time. When you need to preserve large capital for certain purpose like higher education of children, bonds are ideal investment vehicle.

Reinvesting the annual interest ensures that you beat inflationary depreciation of capital.

Bonds are also secured than equities. As an investor in bonds you become creditor. A creditor have higher claim on assets than shareholders if a company goes bankrupt. In such unfortunate case, a creditor gets his dues prior to a shareholder.

Bond investment may not give you higher return than equities but it should be included in your portfolio. When you are young, invest smaller fraction of your investment in bonds and higher in equities.

This acts as buffer to absorb shocks of volatility in equity market. As you approach retirement, gradually convert your equity investments in secured instruments like bonds.