Data Notice: Yield data cited in this article reflects market conditions as of early 2026 and will change. Verify current rates with your brokerage or TreasuryDirect.gov.

This article is for informational and educational purposes only. It does not constitute personalized financial or investment advice. Consult a qualified professional before making investment decisions.

Bond Basics: Types, Yields, Duration, and Risk Explained

Bonds are the other half of a diversified portfolio, providing income, stability, and a counterweight to stock market volatility. Yet many investors hold bond funds without understanding what they own, how bond prices move, or why duration matters. This guide covers the essential mechanics every investor should know.

What Is a Bond?

A bond is a loan you make to a borrower — a government, municipality, or corporation. In exchange, the borrower pays you:

Regular interest payments (called “coupon” payments), typically semiannually
Return of your principal (the “face value” or “par value”) at maturity

If you buy a $10,000 Treasury bond with a 4% coupon that matures in 10 years, you receive $200 every six months ($400/year) and your $10,000 back at maturity.

The Three Major Bond Types

Treasury Bonds (U.S. Government)

Treasuries are backed by the full faith and credit of the U.S. government, making them the benchmark for “risk-free” investments.

Type	Maturity	Current Yield Range (Early 2026)
Treasury Bills (T-Bills)	4 weeks to 1 year	~4.0% - 4.3%
Treasury Notes	2 to 10 years	~3.8% - 4.2%
Treasury Bonds	20 to 30 years	~4.3% - 4.6%
TIPS	5, 10, or 30 years	~2.0% - 2.3% real yield
I Bonds	30 years (redeemable after 1 year)	~4.03% composite

Source: U.S. Treasury — TreasuryDirect

Tax treatment: Interest is exempt from state and local income taxes but subject to federal tax. TIPS and I Bonds have special inflation-adjustment tax rules — see our I Bonds vs TIPS comparison.

Corporate Bonds

Corporations issue bonds to raise capital. Corporate bonds offer higher yields than Treasuries to compensate for default risk.

Investment-grade corporate bonds (rated BBB/Baa or higher) carry relatively low default risk. As of late 2025, the Bloomberg US Corporate Bond Index averaged a yield-to-worst of approximately 4.8%, compared to its 2010-2021 average of 3.2%.

High-yield bonds (rated BB/Ba or lower, also called “junk bonds”) offer substantially higher yields — typically 6-9% — but with meaningful default risk. Historical default rates for high-yield bonds average 3-5% annually, spiking during recessions.

Source: Charles Schwab — 2026 Corporate Credit Outlook

Tax treatment: Interest is fully taxable at federal, state, and local levels.

Municipal Bonds

Municipal bonds (“munis”) are issued by state and local governments to fund infrastructure, schools, and public projects.

Tax advantage: Interest on most municipal bonds is exempt from federal income tax. If you buy bonds issued by your home state, the interest is typically exempt from state taxes as well — making them particularly attractive for investors in high-tax states.

2026 municipal yields: The 10-year AAA municipal yield opened 2026 at approximately 2.70%. The AAA municipal curve had 119 basis points of slope from 10 to 20 years, creating opportunities for investors willing to extend duration.

Source: Morgan Stanley — Steep Muni Yield Curve Highlights Potential Gains in 2026

Tax-equivalent yield: To compare a muni bond to a taxable bond, calculate the tax-equivalent yield:

Tax-equivalent yield = Municipal yield / (1 - your marginal tax rate)

A 3.0% muni bond for someone in the 32% federal bracket has a tax-equivalent yield of 4.41% — comparable to a taxable bond yielding the same.

Credit Ratings: Measuring Default Risk

Three agencies — Moody’s, S&P Global, and Fitch — assign credit ratings that measure the likelihood of a bond issuer defaulting on payments.

S&P / Fitch	Moody’s	Category	Default Risk
AAA	Aaa	Highest quality	Extremely low
AA	Aa	High quality	Very low
A	A	Upper medium	Low
BBB	Baa	Medium grade	Moderate
BB	Ba	Speculative	Elevated
B	B	Highly speculative	High
CCC/CC/C	Caa/Ca/C	Substantial risk	Very high
D	C	In default	Default occurred

The BBB/Baa line is critical — everything above is “investment grade,” and everything below is “high yield” or “junk.” Many institutional investors and bond funds are restricted to investment-grade holdings.

Municipal credit has been strengthening. S&P upgraded more municipal credits than it downgraded for 18 consecutive quarters through 2025, and municipal defaults have remained historically low.

Understanding Yield

Bond yield is not as simple as the coupon rate. Several yield measures exist:

Coupon rate: The fixed interest rate stated on the bond. A $1,000 bond with a 4% coupon pays $40/year.

Current yield: Annual coupon divided by the current market price. If that 4% coupon bond trades at $950, the current yield is $40 / $950 = 4.21%.

Yield to maturity (YTM): The total return you earn if you hold the bond to maturity, accounting for the price you paid, coupon payments, and principal repayment. This is the most comprehensive yield measure and the one most commonly quoted.

Yield to worst (YTW): For bonds with call provisions (where the issuer can repay early), this is the lowest yield you could receive across all possible call dates and maturity.

The Yield Curve

The yield curve plots yields across different maturities. Its shape tells you about market expectations:

Normal (upward-sloping): Longer maturities pay higher yields. This is the typical shape because investors demand more compensation for locking up money for longer periods.

Flat: Short-term and long-term yields are similar. Often signals economic uncertainty or a transition period.

Inverted: Short-term yields exceed long-term yields. Historically associated with impending recessions, though the relationship is not perfectly reliable. The yield curve was inverted through much of 2023-2024 before normalizing.

As of early 2026, the yield curve has returned to a normal upward slope, with the 10-year Treasury yielding approximately 0.3-0.5% more than the 2-year Treasury.

Duration: The Key Risk Metric

Duration measures a bond’s sensitivity to interest rate changes. It is expressed in years and tells you approximately how much a bond’s price will change for a 1% move in interest rates.

Duration	Price Change if Rates Rise 1%	Price Change if Rates Fall 1%
2 years	-2%	+2%
5 years	-5%	+5%
10 years	-10%	+10%
20 years	-20%	+20%

Practical example: If you hold a bond fund with a duration of 6 years and interest rates rise by 1%, the fund’s value will decline approximately 6%. If rates fall 1%, it gains approximately 6%.

This is why 2022 was devastating for long-term bond holders — the Federal Reserve raised rates aggressively, and the Bloomberg US Aggregate Bond Index (with a duration of ~6.5 years) lost over 13%.

Managing Duration Risk

Short-duration funds (1-3 years): Less price volatility, lower yields. Suitable for money needed within 1-5 years.
Intermediate-duration funds (4-6 years): Moderate volatility and yield. The core holding for most portfolios.
Long-duration funds (7+ years): Higher yields but significant price swings. Suitable only for long-horizon investors or as a hedge against stock market declines.

For investors building a retirement portfolio, understanding duration is essential for asset allocation decisions.

Bond Risks Beyond Default

Interest rate risk: Rising rates reduce bond prices (duration effect). This is the primary risk for investment-grade bonds.

Inflation risk: Fixed coupon payments lose purchasing power as inflation rises. TIPS and I Bonds address this directly — see our inflation-protected investment guide.

Reinvestment risk: When bonds mature or are called, you may need to reinvest at lower rates. A bond ladder (holding bonds maturing at different intervals) mitigates this.

Liquidity risk: Corporate and municipal bonds can be harder to sell quickly at fair prices than Treasuries. Bond ETFs and mutual funds mitigate this for individual investors.

Credit/downgrade risk: An issuer’s credit quality can deteriorate, reducing the bond’s price even if no default occurs.

How to Invest in Bonds

For most individual investors, bond index funds and ETFs provide the simplest approach:

Fund Type	Example Funds	What It Holds
Total U.S. bond market	BND, AGG, SCHZ	Mix of Treasuries, corporates, MBS
Treasury-only	GOVT, VGSH, SCHO	Only U.S. government bonds
Corporate investment-grade	LQD, VCIT	BBB-rated and above corporate bonds
Municipal bonds	MUB, VTEB	Tax-exempt state and local bonds
High-yield corporate	HYG, JNK	Below investment-grade corporate bonds

For a deeper understanding of how bonds fit into a complete portfolio, see our guide to investment basics: stocks, bonds, and ETFs.

Key Takeaways

Bonds are loans — you lend money and receive interest plus principal repayment at maturity
Three main types serve different purposes: Treasuries for safety, corporates for higher yield, munis for tax-free income
Credit ratings (AAA through D) measure default risk — the BBB/Baa line separates investment grade from junk
Duration measures interest rate sensitivity — a bond with 6-year duration loses approximately 6% if rates rise 1%
The yield curve shape signals economic expectations — normal (upward), flat (uncertainty), or inverted (recession risk)
Most investors should use bond index funds rather than individual bonds for diversification and liquidity

Next Steps

Compare I Bonds vs TIPS for inflation protection
Review asset allocation by age for your bond allocation target
Learn about tax-loss harvesting strategies for bond funds in taxable accounts
Understand capital gains tax rates on bond interest income

Sources:

This article is for informational and educational purposes only. It does not constitute personalized financial, investment, or tax advice. Consult a qualified financial professional before making any financial decisions.