The principle advantage of bonds is that they're rated in their risks. The bond has a term where it pays off (say 10 years) at which point you get your initial investment back. Bonds will pay a steady income of whatever their return rate is, taken as a percentage of the initial investment. Thus, if you invest $100 000 in a series of bonds that return interest at a coupon rate of 3.5%, each year, you'll get $3 500 of interest income. The big advantage of bonds is their steady income stream, and that you get the initial investment back when you're done.

Sounds simple, right? Here's where it gets a bit more complicated, but, more profitable. The key is in establishing what is the best strategy when it comes to investing in bonds. The answer of course, is it depends! What types of bonds are you looking at buying? Short term (which are less than 5 years in length of term) usually have a low coupon rate, however, your investment isn't tied up for a longer duration. This may prove helpful if there is a chance that you may need access to your funds in the case of an emergency, as odds are, you will have a bond maturing around the time you'll need it most. Medium bonds can tie up your money for 5-10 years, while long term bonds can enjoy a term of 10-30 years. The coupon rate will also vary depending on the credit worthiness. A lower credit rating often means a higher coupon rate (to match the higher risk involved), while a high credit rating is rewarded with a lower coupon rate (and less volatility and risk).

While the coupon rate is the most understand concept in bond investing, its not necessarily where all the money is made. Remember, people buy and sell bonds well before their maturity date. As such, when the interest rate moves lower, the price of an existing bond moves higher, thanks to its higher rate of return than a newer bond would provide. On the flip side, if interest rates move higher, the bond price moves lower, simply because new bonds will now provide a higher rate of return than your existing ones. If you make the call on the direction of interest rates correctly, you'll find yourself in the money by a few percentage points. That can make a huge difference in your portfolio.

The last element of bond investing to look at is the yield of the bond. While its more involved, it is simple to calculate. The yield rate is calculated as the ratio of the annual return of the coupon rate, divided by the current purchase price of the bond. Wow. How about an example: remember our $100 000 bond that was paying us $4000 a year, which gives us a yield of 4%. That of course is presuming its been bought at $100 000. What if it were purchased at $90 000 (due to an increase in the interest rate)? It would still return $4000 per year, however, the yield would be 4.44% ($4 000 / $90 000). Just as the purchase price varies inversely with the interest rates, so will the yield.

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