While stocks often get more attention, the global bond market is larger by one widely cited measure: total outstanding market value. In 2024, global fixed income markets outstanding totaled $145.1 trillion compared with $126.7 trillion for global equity markets. That scale helps explain why bonds matter. They’re worth considering for institutional investors as well as for individuals building a diversified portfolio.1
What are bonds?
At their core, bonds are loans. When you invest in a bond, you are lending money to a government, municipality, or company in exchange for regular interest payments and the return of principal at a future date known as maturity. U.S. Treasury securities, corporate bonds, and municipal bonds all follow this same basic structure even though their risks and tax treatment can differ.
Many bonds pay a fixed rate of interest over their lives, which is why they’re often grouped under the term fixed income. Treasury notes and bonds, for example, generally pay interest every six months, and many municipal bonds also make periodic interest payments before returning principal at maturity. Some exceptions exist, such as floating-rate notes and zero-coupon securities, but the central idea is the same: Bonds can provide a more predictable stream of income than stocks.
Why investors use bonds
Bonds can serve several roles in a financial plan. They may help provide income, reduce overall portfolio volatility, and offer diversification. That doesn’t mean bonds are risk-free. Even high-quality bonds can lose market value when interest rates rise, and lower-quality bonds may be more vulnerable to credit problems or default.
For many investors, the value of bonds is not that they eliminate risk, but that they can help manage it differently than equities do. A thoughtful bond allocation may help support liquidity needs, spending goals, and overall portfolio resilience over time.
Common types of bonds
Several major categories of bonds exist, each with distinct characteristics.
- U.S. Treasury securities (Treasuries) are issued by the federal government and include bills, notes, bonds, Treasury Inflation-Protected Securities (TIPS), and floating-rate notes.2 Though they still carry interest rate and inflation risk, Treasuries are generally considered among the safest investments because they are backed by the full faith and credit of the U.S. government.
- Municipal bonds are issued by states, cities, counties, and other public entities to fund projects and operations. Interest on many municipal bonds is exempt from federal income tax and, in some cases, state and local income taxes. Municipal bonds can be backed either by an issuer’s general taxing authority or by revenue from a specific project.
- Corporate bonds are issued by companies to raise capital. They typically offer higher yields than Treasuries because investors take on the greater credit risk that the issuer may not make interest payments or return principal in full and on time. Lower-rated corporate bonds, often called high-yield bonds, typically pay more interest in exchange for that added risk.
- Sovereign bonds are issued by foreign governments. Like other bonds, their risk and return profile depends on factors such as the issuer’s credit quality, interest rate environment, and currency exposure.
Bond risks to understand
Two important bond risks are credit risk and interest rate risk.
Credit risk, also called default risk, is the risk that an issuer may not make promised interest or principal payments. This risk can vary widely across issuers, which is part of why investors should pay attention to credit ratings and the underlying financial strength of the borrower.
Interest rate risk is the risk that a bond’s market value may fall if interest rates rise. The U.S. Securities and Exchange Commission notes that bond prices and market interest rates generally move in opposite directions: When rates go up, prices of fixed-rate bonds typically fall; and when rates go down, prices generally rise.3 Longer-term bonds usually experience larger price swings than shorter-term bonds when rates change.
Inflation risk also matters. Even if a bond pays interest exactly as promised, rising inflation can reduce the purchasing power of those future payments. TIPS are one example of a bond designed to help address that risk by adjusting principal for changes in the Consumer Price Index.
Bond prices and yields: why they move in opposite directions
One of the most important concepts in fixed income is the inverse relationship between bond prices and yields. A bond’s current yield is a simple measure of the annual income it produces relative to its current market price. The current yield is the ratio of the interest payable on a bond to its actual market price, expressed as a percentage.
Because coupon payments on many bonds are fixed, the market price has to adjust when interest rates change. If new bonds are issued with higher rates, older bonds paying lower coupons become less attractive, so their prices generally fall. If new bonds are issued with lower rates, older bonds with higher coupons may become more valuable, so their prices generally rise. That is why yields move up when prices fall and down when prices rise.
If you hold an individual bond to maturity, short-term market price fluctuations may matter less to your principal repayment (assuming the issuer remains able to pay). But those price changes can matter if you need to sell before maturity or if you own bond funds with share prices that reflect changes in the market value of underlying holdings.
How bonds can fit into an investment portfolio: 3 scenarios
Bonds can play different roles depending on your goals and stage in life — whether you’re approaching retirement, in retirement, or in accumulation years. In each case, the value of bonds isn’t just in the income they produce but in how they contribute to a more balanced, resilient portfolio aligned with a long-term financial plan.
1. Preretirement: reducing volatility and protecting near-term goals
Scenario
Sarah, 58, plans to retire in five years. A significant portion of her portfolio is invested in equities, but she’s concerned about a market downturn just before retirement.
How bonds help
Sarah shifts part of her portfolio into high-quality bonds, such as U.S. Treasuries and investment-grade corporates. This allocation helps reduce overall portfolio volatility and provides a more stable pool of assets for near-term withdrawals.
Why it applies to this scenario
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- Bonds tend to be less volatile than stocks, especially over shorter time horizons.
- High-quality bonds have historically shown a tendency to preserve capital.
- A bond allocation can act as a buffer during equity market declines.
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Planning takeaway
As retirement approaches, bonds can help transition a portfolio from growth-focused to more income- and stability-focused — particularly for assets needed in the next 3-7 years.
2. Retirement: generating consistent cash flow
Scenario
David and Maria, both 68, are retired and relying on their portfolio to supplement Social Security. They want predictable income without selling equities during down markets.
How bonds help
They build a diversified bond allocation, including municipal bonds (for tax efficiency) and a ladder of Treasuries and corporate bonds that mature over time. Interest payments provide a steady income stream, while maturing bonds help fund ongoing expenses.
Why it applies to this scenario
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- Bonds typically pay regular interest (coupon) payments.
- A laddered bond strategy can create predictable liquidity over time.
- Municipal bonds may offer tax advantages depending on the investor’s situation.
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Planning takeaway
Bonds can form the foundation of a retirement income strategy by providing consistent cash flow and reducing reliance on market timing.
3. High-net-worth investor: managing risk and diversification
Scenario
Alex, 45, has a high income and a large, equity-heavy portfolio. While focused on long-term growth, Alex wants to better manage risk across market cycles.
How bonds help
Alex incorporates a diversified bond allocation across Treasuries, municipals, and selectively chosen corporate bonds. This allocation isn’t designed to maximize returns but to improve overall portfolio balance and resilience.
Why it applies to this scenario
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- Bonds often respond differently than equities to market conditions, which can contribute to diversification.
- Interest rate movements can create opportunities within fixed income.
- High-quality bonds can provide liquidity during periods of market stress.
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Planning takeaway
Even for growth-oriented investors, bonds can serve as a stabilizing force — helping manage downside risk and supporting rebalancing opportunities over time.
The bottom line
Bonds can play an important role in a diversified portfolio, but understanding how they work is essential. Knowing the difference between bond types, recognizing the trade-offs between risk and return, and understanding the relationship between prices and yields can help you make more informed decisions about how fixed income fits into a long-term financial plan.
Understanding how bonds work is one step toward building a portfolio aligned with your goals, income needs, and long-term plan.
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A bond is a loan you make to a government, municipality or company. In return, the issuer typically agrees to pay interest and repay your principal at maturity.
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No. Even high-quality bonds carry risks, including interest rate risk and inflation risk, and some bonds also carry meaningful credit or default risk. U.S. Treasuries are generally considered among the safest because they are backed by the full faith and credit of the U.S. government, but they are not free from all risk.
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Most bonds pay a fixed coupon. When newer bonds offer higher rates, older bonds with lower coupons typically become less attractive, so their prices usually fall until their yields become more competitive.
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Bond yield is a measure of return. One simple version, current yield, is calculated by dividing a bond’s annual interest payment by its current market price.
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Common bond categories include U.S. Treasury securities, municipal bonds, corporate bonds and sovereign bonds. Each comes with its own mix of credit risk, tax considerations and interest rate sensitivity.
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Bonds can help provide income, support liquidity needs, and diversify a portfolio that also holds equities. Their role varies based on an investor’s goals, time horizon and tolerance for risk.
- “Capital Markets Fact Book.” SIFMA, July 28, 2025.
- “About Treasury Marketable Securities.” U.S. Department of the Treasury, 2026.
- “When Interest rates Go up, Prices of Fixed-rate Bonds Fall.” U.S. Securities and Exchange Commission, 2026.
All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. Different types of investments involve varying degrees of risk, investments mentioned in this document may not be suitable for all investors. Investments are subject to market risk, including the possible loss of principal. Portfolio management strategies such as diversification, asset allocation, and rebalancing do not ensure a profit or guarantee against loss.
Hypothetical examples are for illustrative purposes only.
