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Investing in bonds: Rick Santelli's 5 things you need to know

Bonds: The essential I-O-U you need to know about
Bonds: The essential I-O-U you need to know about

If the thought of investing in bonds overwhelms you, you aren't alone.

Between the different types of securities and the varying yields available in the $43.1 trillion dollar bond market, investors may have a hard time sorting it all out.

Yet if you want a balanced portfolio, experts say it's important to include fixed-income assets. That's because stocks tend to be riskier, while bonds are considered a safer investment. In fact, the age-old rule of thumb is the "60-40" rule — which means 60% of your portfolio should be in stocks and 40% in fixed-income.

So, what do you need to know when it comes to bonds?

CNBC on-air editor Rick Santelli has the answers to five key questions.

What exactly is a bond?

Douglas Sacha | Getty Images

Quite simply, it's an IOU, Santelli said.

When corporations or governments need to borrow money, they issue bonds.

Government bonds in the U.S. include those from the federal government, called Treasurys, as well as municipal bonds, which are issued by state and local municipalities. Foreign governments also issue bonds.

How long does it last?

The life, or maturity, of bonds vary.

For example, you can buy short-term debt through a Treasury bill, or T-Bill. They range from a few days to 52 weeks.

You can also invest in long-term corporate or government bonds, such as the 30-year U.S. Treasury — or find a happy medium, somewhere in between.

You should know these two primary functions of The Fed
You should know these two primary functions of The Fed

How do you make money?

By investing in bonds, you are lending the government or a corporation money and they pay you for that in the form of interest.

How much do you earn?

The return on your investment depends on the interest payment, also known as the coupon.

It is generally established at the time of issuance and is agreed upon by both parties, Santelli explained.

For example, if you have a $100 bond that gets 1% interest, you are going to get $1 every year or 50 cents every six months, he said.

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How do you know if you're getting a good deal?

Look at the bond's credit quality, Santelli said. That will let you know the asset's credit worthiness or risk of default.

"The better the credit quality, the less you are going to get in terms of interest payments," Santelli said. "Government IOUs are the best quality, so many times they pay the lowest interest but they are considered the safest."

Independent credit agencies, such as Standard & Poors and Moody's, assign ratings to bonds depending on their quality. For example, 'AAA' to 'AA' is the high range, while 'CCC,' 'C,' and 'C' is in the low-range.

The lower the rating, the higher the risk.

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Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.