Just like how the fast lane and the slow lane on the freeway eventually lead to the same place, there are both quick and slow ways to double your money. So for those investors who are afraid of wrapping their portfolio around a telephone pole, bonds may provide a significantly less precarious journey to the same destination.
But investors taking less risk by using bonds don't have to give up their dreams of one day proudly bragging about doubling their money. In fact, zero-coupon bonds (including classic U. S. savings bonds) can keep you in the "double your money" discussion.
For the uninitiated, zero-coupon bonds may sound intimidating. In reality, they're surprisingly simple to understand. Instead of purchasing a bond that rewards you with a regular interest payment, you buy a bond at a discount to its eventual maturity amount. For example, instead of paying $1,000 for a $1,000 bond that pays 5% per year, an investor might buy that same $1,000 for $500. As it moves closer and closer to maturity, its value slowly climbs until the bondholder is eventually repaid the face amount.
One hidden benefit that many zero-coupon bondholders love is the absence of reinvestment risk. With standard coupon bonds, there's the ongoing challenge of reinvesting the interest payments when they're received. With zero coupon bonds, which simply grow toward maturity, there's no hassle of trying to invest smaller interest rate payments or risk of falling interest rates.
