In essence, a bond is an "IOU" from an issuer to an investor. A bonds issuer agrees to repay the investor the principal amount invested at the bonds maturity date, along with regular interest payments at the bonds stated coupon rate. Bonds can help to diversify an equity portfolio, and can provide investors with a steady income stream.
Like all investments, however, bonds do carry risk. Bond risks include credit risk, market risk, interest rate risk, and inflation risk. Some bonds such as high-yield or "junk" bonds carry relatively high risk and may be most appropriate for investors who can withstand significant price fluctuations.
Most bonds fall into four general categories: corporate, government, government agency, and municipal. Corporate bonds are issued by corporations and generally carry the highest risk of the four general categories. Government bonds are among the safest because they are issued by the U.S. Treasury and backed by the full faith and credit of the U.S. government. The risks associated with government agency and municipal bonds vary, but usually fall in between corporate and government bonds on the risk spectrum.
The wide variety of bonds may make them potentially suitable in many investment scenarios. Discuss your goals with your financial advisor, and together you can decide whether bond investing is right for you. When investing in tax-exempt municipal bonds, keep in mind that the federal alternative minimum tax (AMT) could apply.