A bond is the same thing as a loan, more or less, except for the method of repayment.
Bonds are interest only until the last day of the loan, at which time the entire original amount borrowed is payable.
If you buy a 20 year $1000 bond at 3%, then you are entitled to (1000 x 3 / 100) $30 per year for 20 years and on the last day you receive back the entire 1000. Your income from the bond, in this scenario, would be (30 x 20) $600.
Banks pay taxes on interest you pay them for loans and it’s the same thing with bonds, the amounts above what you paid in are taxable.
It’s important to note that bonds are very heavily impacted by interest rates. The interest rate that somebody is willing to pay for a bond might be 3% above whatever the Federal Reserve is charging to loan money. For a long time now, the Federal Reserve rate has been 0%.
If the Federal Reserve increases that rate, like they have pledged to do recently, to maybe 1% then new bonds would have interest rates of 4% while bonds bought prior would still be paying 3%.
The interesting thing to note here is that older bonds can be made to have a higher interest rate by paying less for them. Those bonds sold for 20 years $1000 at 3% can be pushed up in income by buying them for below $1000 say maybe $900. The seller, in this case, would get less than their expected 3% due to the $100 loss and the buyer would get $1000 on the last day while only paying $900 to buy it, which would kick in a $100 gain in addition to them receiving the same 3% interest you were getting.
Because of how impacted bonds are by interest rates, it’s relatively worse to buy bonds in low interest rate environments, like the one we are in now. If interest rates rise in the future, their selling values will drop substantially. Generally, you do not want to lock yourself into multiple decades of low interest rates if you can avoid it. If you must get a low rate bond, you might want to consider trying to get one that is only for a few years. At the end of that time you might be able to take the repayment and buy new bonds with a higher interest rate and therefore a better payout.
Similarly, if you buy bonds in high interest rate environments, if the interest rates go down you can sell them for potentially a lot more than you paid for them. If you are buying bonds at high interest rates, it helps to lock in the results for as long as you possibly can. If you can lock in a long term high interest rate, you don’t have to suffer through years of receiving your money back and maybe being forced to buy bonds at lower interest rates.
It’s not possible to re-invest bond interest at the same interest you are receiving on the bonds you already have. All you can do is re-invest bonds at the then current interest rates. This is a seriously negative aspect of bond investing. Your returns are very nearly completely out of your control. Getting good returns from bonds means buying bonds and hoping the interest rate goes down and not buying more bonds in the mean time.
Still, this is what most people are encouraged to use to fund their retirements. The consistent payments, backed up often by the government’s ability to print money, is a pretty stable income source in retirement. A lot of people cash out all of their more risky investments when they retire and buy bonds with all their money in an attempt to secure safety of principal.