By: Jaime Malm, owner/founder of Iron Horse Financial Services
If you’ve ever wondered why your bond investments seem to rise and fall even though they’re supposed to be “safe,” you’re not alone. As your financial advisor, I want to help you understand the why behind those changes—and more importantly, how they affect your income, especially if you’re retired or getting close.
Buying a bond is a lot like lending money to someone. You’re agreeing to let, for example, a government or company borrow your money, and in return, they promise to pay you interest (usually annually) and give your original money back later.
Let’s say you buy a bond for $1,000 that pays you $50 a year for 10 years. That $50 payment is called a coupon, and it doesn’t change once you’ve bought the bond. Now imagine this: You bought that bond, and then a few months later, interest rates in the market change.
Here’s the key thing to know:
- When interest rates go up, the value of your bond goes down.
- When interest rates go down, the value of your bond goes up.
Why? Think about it like this…
Imagine you bought a coupon book that gives you $50 a year. If new coupon books are now paying $70 a year, yours suddenly looks like a worse deal. No one will want to buy it from you at full price. You’d have to sell it for less—its value goes down.
But if new books are only paying $30, your $50-a-year coupon book looks amazing. People would happily pay more for it—its value goes up.
The value of a bond and the yield off a bond is not the same and it can get confusing.
Yield is like your car’s gas mileage. It tells you how efficient your bond is at giving you a return based on what you paid.
If you buy a $1,000 bond that pays $50 a year, your yield is 5%. But if the bond’s value drops to $900 and still pays $50, the yield jumps to 5.6%. You’re earning more on the money you put in, because you paid less for the same income.
So:
- Interest rates = what the market is doing.
- Bond value = what your bond is worth right now.
- Yield = what return you’re getting based on today’s price.
They’re connected, but not interchangeable.
How are bonds then used to create income? There are two main ways to do this:
- Hold your bonds and collect the coupon payments, like getting a paycheck every year or every six months.
- Sell bonds as needed to raise cash, kind of like snapping off squares from a chocolate bar when you need a snack.
The beauty of bonds is that they can offer reliable income—but here’s where interest rates come back into play.
Let’s go back to our chocolate bar analogy.
If you bought your chocolate bar (your bond) when interest rates were higher, it’s a big bar. You can enjoy a nice-sized bite (income) for a long time. But if you’re buying that same bar when rates are low, it’s smaller. To get the same fullness (income), you may need to break off more pieces, or buy more bars.
That’s why when interest rates drop, generating income from bonds gets harder—especially for new investments. And when rates rise, the silver lining is that new bonds usually offer better income potential.
Understanding how bonds react to interest rates and yields isn’t just financial trivia—it directly affects how much money you can generate in retirement, how stable your portfolio feels, and how confident you are in your plan.
If you’re living off your investments (or planning to in the future), bonds can still play a valuable role. But knowing when and how to buy them, and how to use them for income, is key.