Bonds, Interest Rates & the Fed

1What is a bond?

A stock makes you an owner. A bond makes you a lender. When you buy a bond, you're loaning money to a company or a government. In return, they pay you interest for a while, then give your original money back on a set date called the maturity.

Bonds are usually calmer than stocks — smaller ups and downs — which is why older investors often hold more of them. The trade-off: that calm usually comes with lower long-term growth than stocks.

2The seesaw: rates up, bond prices down

Here's the one surprising rule. Once you own a bond paying a fixed amount, its resale value moves opposite to new interest rates.

Why? If new bonds start paying more than yours, nobody will pay full price for your lower-paying one — so its price drops. If new bonds pay less, yours looks great, and its price rises. Pay less for the same $5/year and your yield goes up. Play with it below.

3Who sets interest rates? The Fed

A huge driver of those rates is the Federal Reserve — the "Fed," the United States' central bank. It nudges a key interest rate up or down to steer the economy: raise rates to cool things down, lower them to speed things up.

You feel it in everyday life, not just bonds:

• Savings accounts — when the Fed raises rates, the interest your savings earns usually goes up too.
• Loans — car loans, credit cards, and mortgages get more expensive when rates rise.
• Bonds — the seesaw you just played with.