Though the term “investing” may first bring to mind the stock market with its many highs and lows, the other component of the well-known pairing “stocks and bonds” may offer more stability and moderate returns.

Bonds are a distinct way of funneling funds into the government or a business that is essentially a type of loan. If you’ve heard the term but never quite understood what it means or how they fit into a financial plan, keep reading to learn the basics.

What a bond actually is

As the American Association of Individual Investors (AAII) explains, when you purchase a bond, you are lending money to an issuer—typically a corporation, government, or municipality—in exchange for them making regular interest payments to you. At the end of the bond’s maturity date, the issuer will also return your original loan amount, called the principal or par value. The interest payments you receive along the way are called coupon payments. Bonds are typically issued in $1,000 increments, and interest is usually paid semiannually.

The main types of bonds

There are three primary categories to consider investing in. US Treasury bonds are issued by the federal government and are generally considered among the safest fixed-income options available since they are backed by the full faith and credit of the United States.

Municipal bonds, sometimes called munis, are issued by state and local governments; they are often exempt from federal income taxes and, in some cases, state taxes as well, which may make them particularly appealing if you are an investor in a higher tax bracket.

Corporate bonds are issued by companies and tend to offer higher interest rates than government bonds—but with greater credit risk depending on the financial health of the issuer. Forbes notes that corporate bonds range from investment-grade issues with strong credit ratings to high-yield bonds, sometimes called junk bonds, which carry an elevated risk in exchange for a higher potential yield.

How interest rates affect bond prices

One of the more confusing concepts about bond investing for many people is the inverse relationship between interest rates and bond prices. When interest rates rise, the prices of existing bonds may actually fall because newer bonds are being issued at higher rates, making older ones less attractive by comparison. The reverse is also true: When rates decline, existing bonds that were issued at higher rates become more valuable. Charles Schwab’s fixed income outlook highlights that this dynamic is particularly pronounced with longer-term bonds, which are more sensitive to rate movements than shorter-term ones. This interest rate risk is one of the primary factors to consider when selecting bonds.

The role bonds may play in a portfolio

Bonds are often included in portfolios to provide stability and income alongside more volatile assets like stocks. In fact, recent yields have been meaningfully above what traditional savings accounts have offered. That said, bonds are not risk-free. Credit risk, inflation risk, and the interest rate sensitivity described above all apply, and the right allocation to bonds depends on your time horizon, income needs, and tolerance for volatility.

How to invest in bonds

You don’t have to buy individual bonds to gain exposure to fixed-income markets. Bond mutual funds and exchange-traded funds (ETFs) allow you to invest in a diversified bundle of bonds through a single purchase, often with low minimum investment requirements. AAII notes that these funds can be held within brokerage accounts or retirement accounts like IRAs and 401(k)s. US Treasury bonds can also be purchased directly from the government at no cost through TreasuryDirect.gov.

For investors who are newer to fixed income, starting with a diversified bond fund may be a more accessible entry point than selecting individual bonds, which requires a deeper understanding of credit quality, duration, and yield.

Bonds are a well-established part of the investment landscape, and understanding how they work is a worthwhile foundation for any investor. Whether they belong in your portfolio, and in what proportion, depends on factors specific to your situation—which is why you may want to discuss them with a financial advisor as a first step.