Stock Market

Maybe you're not the type that likes to take big chances. You like to know what's coming around the corner, and, if you can't, you at least like to have a back-up plan to deal with life's little boomerangs. If this is you, there are two words you need to remember: fixed income. A fixed-income security entitles you to regular, fixed payments of interest income on your investments.

Bonds and notes are fixed-income securities that corporations, municipalities, and governments issue to borrow money. When you buy a bond or note, you are agreeing to lend the entity that issued it a certain amount of money. In return, the company gives you a fixed-income security and promises to make specified interest payments to you and return the full amount borrowed when the security matures. The interest that is to be paid to you, the timing of those payments, and the maturity date are all spelled out in a document known as the indenture.

When corporations raise money using fixed-income securities, it's called debt financing. When they issue stock to raise money, it's called equity financing. It may surprise you to learn that, although the stock market receives more coverage on the nightly news, the bond market is far, far larger!

TIP: Bonds, notes, and bills are all IOUs that corporations and governments issue when they want to borrow money. The borrower promises to pay you interest as well as return the principal amount you lent it at a specific date in the future (this is known as the maturity date). In the case of the United States government, these IOUs are called bonds when the specified date is longer than 10 years from the date the bond is issued. When the maturity date is between 1 and 10 years from issuance, the IOU is a known as a note. When it's 1 year or less from issuance, the IOU is called a bill.

Bonds and other fixed-income securities balance out the risk of carrying stocks in your portfolio. Unless you lend money to a borrower with lousy credit, you can count on getting your money back when the fixed-income security matures. Plus, you earn all that interest income in the meantime.

When the stock market is tanking, it can be a great relief to know that you have some of your money in nice, safe bonds. Even better, when the stock market is performing miserably, the bond market tends to do really well, and vice versa. This seesaw effect keeps your portfolio on an even keel when you own both stocks and bonds. The events of 2001 and 2002 are good examples.