Bonds: What Are They and How Do They Work?

Bonds: What Are They and How Do They Work?

Saving money is great, but if it just sits in your account, inflation eats away at its value. Investing in bonds is one way to put your money to work while keeping risk low. Popular investment options include bank deposits, stocks, cryptocurrency, and bonds. Today, we’ll explain what bonds are, how they work, and their advantages and disadvantages.

What Are Bonds?

A bond is a type of investment where you lend money to a company or government, and in return, they promise to pay you back with interest. It’s essentially a loan, but instead of lending to an individual, you’re lending to a large entity. When the bond matures, you get back your initial investment along with any interest earned.

To better understand this financial tool, consider the key parameters of bonds:

1. Face Value – The initial loan amount. 
2. Maturity Date – The date when the borrower repays the principal and interest to the creditor.
3. Yield – The annual return on coupon bonds, which remains fixed until maturity.

Yield – The annual return on coupon bonds, which remains fixed until maturity. Bonds today can offer significantly higher yields than traditional bank deposits — up to 7.6%, compared to the current average of 2.5% offered by banks. Check the selection of secure and profitable bonds rated B+ and higher here.

Check the selection of secure and profitable bonds rated B+ and higher here.

Bonds come in different types. For example, in the UK, perpetual bonds were issued with no maturity date, and holders continue to receive interest payments indefinitely.

Types of Bonds

Bonds can be classified based on different parameters:

By Income Type

• Coupon Bonds – These offer a fixed (or sometimes floating) annual interest rate.
  • Example: If you invest €1,000 in a bond with a 13% annual interest rate, you'll earn €130 per year until the bond matures.
  •  
• Discount Bonds – Profit is generated by the price difference. The investor buys a bond below face value and sells it at full value.
  • Example: Buying a bond for €1,000 and selling it for €1,200.

By Maturity Period

• Short-term (up to 1–2 years)
• Medium-term (2–5 years)
• Long-term (more than 5 years)
• Perpetual (no maturity obligation, applies only to coupon bonds)

By Currency of Issuance

• In national currency (EUR is convenient since no currency exchange is needed)
• In foreign currency (typically in USD, suitable for those earning or saving in dollars) 

By Issuer Type

• Corporate Bonds – Issued by companies to raise funds for business operations.
• Municipal Bonds – Issued by local governments to finance projects.
• Government Bonds – Issued by the state or government agencies to cover budget deficits. 

The most popular and straightforward are government coupon bonds, as they offer fixed returns with minimal risks—since a country's default is highly unlikely. You can buy bonds from both your home country’s government and foreign issuers (e.g., U.S. corporate bonds).

Investing in Bonds: Pros and Cons

Like any other investment tool, bonds have advantages and disadvantages.

Advantages

• Liquidity – Most bonds can be bought or sold within a day.
• Safety – Bonds carry very low risk as their repayment is guaranteed by the issuer (e.g., the government). Even if a company goes bankrupt, bondholders are among the first to receive payments.
• Stability – Fixed annual income (for coupon bonds), which remains unchanged over time and helps offset inflation.
• Low or no taxes – Especially for government bonds, as governments encourage their purchase by offering tax benefits.
• Low entry threshold – You can start investing with as little as €1,000, whereas buying stocks, especially of foreign companies, might require €100–200 per share. 

Disadvantages

• Lower returns compared to stocks and cryptocurrencies – However, this is offset by the almost complete absence of risk.
• Corporate bond risk – If the issuing company goes bankrupt, investors could lose their money. This risk is higher for bonds issued by companies with low ratings and dubious reputations.

Despite these drawbacks, bonds remain a popular investment choice due to their safety and stability.

How to Invest in Bonds?

Investing in bonds is a straightforward process thanks to digitalization and the internet. Follow these steps:

1. Open an account to store securities (handled by the broker or bank).
2. Choose available bonds and decide how much you want to invest.
3. Submit a purchase request.
4. Receive the bonds in your account.

After purchasing, you simply wait for the maturity date, when the issuer repays the face value and interest—usually within three days (often the same day).

Bonds are a great way to earn passive income while minimizing risk. Whether you're a beginner investor or looking for portfolio stability, they can be a smart choice. We recommend to explore your options and invest in bonds with Freedom24 broker. With Freedom24 you will access to over 147,000 government, municipal, and corporate bonds from developed and emerging markets. Enjoy stable and predictable fixed income with flexible maturity options, various issue currencies, and automated income payments.

A Wide Range of Bonds

✔ 53,000 corporate, 90,000 municipal, and 4,000 sovereign bonds
✔ Exchange-traded and OTC instruments with maturities from 1 to 50 years
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✔ Coupon income is credited directly to your brokerage account within 1–2 days after the issuer’s payment
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✔ Enjoy stable income with reduced risks—bonds are less affected by market fluctuations

Trusted & Secure Investing

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✔ User-friendly platform with a dedicated bond trading tab
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This content contains affiliate links to services we recommend. Please note: investments always involve the risk of loss of your capital. The forecast or past performance is no guarantee of future results. It is essential to do your own analysis before making any investment. 

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