Credit investing is the practice of lending your money to a borrower — a company, a government, or a pool of borrowers packaged together — in exchange for scheduled interest payments and the return of your principal on a set date. When you buy a bond or a loan, you are the lender, not an owner, and you have a contractual right to be repaid before any stockholder collects anything. The interest rate, the payment schedule, and the repayment date are all set at the outset, which is why credit sits at the heart of what the industry calls fixed income.
How the Mechanics Work
Every credit instrument rests on three numbers. The principal (also called par or face value) is the amount you lend. The coupon rate is the annual interest the borrower agrees to pay, expressed as a percentage of principal. The maturity date is when the borrower must return your principal in full. A $10,000 bond with a 5% coupon and a 10-year maturity pays $500 a year for a decade, then hands back the $10,000.
Yield is where things get more interesting. If you buy a bond at issuance for its face value, your yield equals the coupon rate. But bonds trade on a secondary market, and prices float. Pay $9,500 for that same $10,000 bond and you still collect $500 a year, but your current yield rises to about 5.26% because you paid less for the same income stream. The fuller measure is yield-to-maturity, which combines the price you paid, the coupon, and the time left until repayment.
Price and yield move in opposite directions. When market interest rates rise, existing bonds with lower coupons become less attractive, so their prices drop until their yields line up with new issues. Duration measures how sharply a bond’s price will react to a rate change.1FINRA. Bonds, Interest Rate Changes, and Duration A bond maturing in two years barely moves when rates shift. A 30-year Treasury can lose 15% or more of its value on a 1-percentage-point increase.
The Main Types of Credit Instruments
“Credit” covers a wide range of instruments, and the differences drive both the risk you take and the return you earn.
Corporate Bonds
Corporations issue bonds to fund operations, acquisitions, or refinancing. Secured corporate bonds are backed by specific assets — equipment, real estate, receivables — that lenders can claim if the company can’t pay. Unsecured bonds, often called debentures, rely on the company’s overall ability to generate cash and typically pay a higher coupon than secured bonds from the same issuer.
The market draws a hard line between investment-grade corporate bonds (rated BBB- or higher by S&P and Fitch, Baa3 or higher by Moody’s) and high-yield, sometimes called junk, bonds.2S&P Global Ratings. Understanding Credit Ratings High-yield issuers have weaker balance sheets or heavier debt loads, so they pay fatter coupons. The extra yield over a comparable Treasury is the credit spread, which widens in downturns as the market prices in higher default odds.3FINRA. Spread the Word – What You Need to Know About Bond Spreads
Treasuries and TIPS
U.S. Treasury securities carry the lowest credit risk of any dollar-denominated instrument, backed by the full faith and credit of the federal government. They come in three flavors: bills (a year or less), notes (2 to 10 years), and bonds (20 or 30 years). Treasury interest is subject to federal income tax but exempt from state and local income taxes.4Internal Revenue Service. About Tax Topic 403 Interest Received
Treasury Inflation-Protected Securities, or TIPS, add a twist. The principal adjusts up or down with the Consumer Price Index, and while the coupon rate is fixed, it applies to the inflation-adjusted principal, so interest payments grow when prices rise.5TreasuryDirect. Treasury Inflation-Protected Securities (TIPS) TIPS are one of the few credit instruments that directly address inflation risk.
Municipal Bonds
State and local governments issue municipal bonds to finance infrastructure, schools, and other public projects. Their main draw is tax treatment: interest is generally exempt from federal income tax, and if you live in the state that issued the bond, often exempt from state and local taxes too.6Municipal Securities Rulemaking Board. Municipal Bond Basics A muni yielding 3.5% can put more in your pocket than a corporate bond yielding 5%, depending on your bracket. You need to compute the tax-equivalent yield to compare honestly.
Leveraged Loans
Leveraged loans are senior, secured debt extended to companies that already carry significant borrowing. They sit at the top of the borrower’s capital structure and get paid first in a bankruptcy. Their defining feature is a floating interest rate: instead of a fixed coupon, the rate resets periodically against a benchmark plus a spread. The benchmark for dollar loans is the Secured Overnight Financing Rate (SOFR), which replaced LIBOR after LIBOR ceased publication in June 2023.7Federal Reserve Bank of New York. Transition from LIBOR
Because the rate floats, leveraged loans carry less interest rate risk than fixed-rate bonds. When rates climb, your income rises with them. The trade-off is credit risk: these borrowers tend to be heavily indebted. Loan agreements include covenants restricting borrower behavior, and a breach can trigger a technical default that lets lenders step in before things get worse.
Structured Credit
Structured credit takes pools of individual loans and repackages their cash flows into tradable securities. Auto loans feed into asset-backed securities (ABS). Home mortgages become residential mortgage-backed securities (RMBS). Commercial real estate loans become commercial mortgage-backed securities (CMBS). The pooled cash flows are sliced into tranches that absorb losses in a set order: senior tranches get paid first and take losses last, junior tranches absorb the first losses and pay a higher yield.
Credit Ratings
A credit rating is an independent opinion on how likely a borrower is to meet its debt obligations on time. The three dominant agencies — S&P Global Ratings, Moody’s Investors Service, and Fitch Ratings — assign letter grades that run from AAA/Aaa at the top down to D/C for default. Everything above BBB-/Baa3 is investment grade; everything below is speculative grade, or high yield.2S&P Global Ratings. Understanding Credit Ratings
Historical data from Moody’s shows annual default rates for investment-grade issuers averaging well under 1%, while speculative-grade defaults have historically averaged several percentage points per year. That gap is why high-yield bonds pay so much more.
Agencies focus on a handful of financial metrics: debt-to-EBITDA (how many years of operating earnings it would take to pay off the debt), interest coverage (whether earnings comfortably cover annual interest), and cash flow stability. They layer on judgments about industry conditions, competitive position, and management. Covenants matter too — restrictions on additional borrowing, asset sales, or dividends give lenders more control and can support a higher rating. Ratings aren’t static; agencies monitor issuers and revise as conditions change.
The Risks You Actually Face
Credit is often described as safe relative to stocks, but that framing hides several distinct ways to lose money.
Interest Rate Risk
When market rates rise, the fixed coupon on your existing bond looks worse next to new issues, and the market price of your bond falls. The longer the maturity, the steeper the drop. A bond with a duration of 7 years will lose roughly 7% of its value for every 1-percentage-point rise in rates.1FINRA. Bonds, Interest Rate Changes, and Duration Hold to maturity and you still get your principal back; sell early and you may take a loss.
Inflation Risk
Fixed coupons lose purchasing power when prices rise. A bond paying $500 a year buys less each year if inflation runs at 4% or 5%. This is why credit investors watch real yield, the nominal yield minus inflation. A 5% coupon sounds good until inflation is 4.5%, leaving a real return of half a percent. TIPS are the standard hedge for the Treasury portion of a portfolio.
Reinvestment Risk
Reinvestment risk is the flip side of interest rate risk. When rates fall, coupon payments can only be put back to work at the new, lower rates. Buy a 10-year note yielding 6%, watch rates drop to 4%, and the $600 you receive each year now compounds at 4%. The risk is most pronounced during sustained rate-cutting cycles and with callable bonds.
Call Risk
Many corporate and municipal bonds include a call provision letting the issuer buy the bond back early at a set price. Issuers usually call when rates have fallen, so they can refinance cheaper.8FINRA. Callable Bonds – Be Aware That Your Issuer May Come Calling Good for them, bad for you: your income stream ends and you’re reinvesting in a lower-rate environment. Callable bonds usually pay a slightly higher coupon to compensate, but investors regularly underestimate how much a call can shrink total return.
Liquidity Risk
Unlike stocks, most bonds do not trade on a centralized exchange with continuous pricing. Corporate bonds trade over the counter, often through request-for-quote systems where dealers quote prices bilaterally. Many individual issues trade infrequently, and if you need to sell in a hurry, the bid-ask spread can eat into your return. Retail investors typically face wider spreads than institutions trading the same bond in larger sizes. This is one of the strongest practical arguments for funds over individual bonds.
What Happens if a Borrower Defaults
Default doesn’t automatically mean total loss. Recovery depends almost entirely on where your instrument sits in the borrower’s capital structure and whether it’s secured.
When a company enters bankruptcy, federal law sets a strict payment hierarchy. Secured creditors get paid first from the specific assets backing their loans. After that, the Bankruptcy Code sets a priority order for unsecured claims: administrative expenses, employee wages up to a statutory cap, tax obligations, then general unsecured creditors such as bondholders.9Office of the Law Revision Counsel. 11 USC 507 – Priorities In a Chapter 11 reorganization, no junior class can receive anything until every senior class has been paid in full, a principle known as the absolute priority rule. Equity holders stand last and frequently receive nothing.
The gap between secured and unsecured recovery rates is stark. According to S&P Global Ratings data, the long-term average recovery rate for senior secured loans is about 75 cents on the dollar, while unsecured bonds average roughly 40 cents. Those are averages; individual outcomes vary widely by industry, remaining asset value, and market conditions. In 2025, bond recoveries dipped to about 21 cents on the dollar through September, the lowest level since 2001, while loan recoveries held above average at around 88 cents.10S&P Global Ratings. Default, Transition, and Recovery – US Recovery Study Seniority and security aren’t technicalities. They’re the primary drivers of how much you actually get back when something goes wrong.
How to Actually Invest
Your entry point depends on your capital, your tolerance for illiquidity, and how much of the analysis you want to do yourself.
Mutual Funds and ETFs
For most investors, bond mutual funds and ETFs are the simplest path in. Both pool money across dozens or hundreds of issuers, so a single default barely registers. ETFs trade throughout the day on exchanges and typically carry lower expense ratios. Mutual funds are priced once daily against the net asset value of their holdings. Either structure handles the credit analysis, trading, and reinvestment for you.
Buying Individual Bonds
Buying individual bonds gives you control over credit quality, maturity, and coupon, but the trade-offs are real. Most corporate bonds have a $1,000 face value, and diversifying across 20 or 30 issuers takes serious capital. The secondary market for corporates is less liquid than the stock market, and retail investors generally face wider bid-ask spreads than institutions trading the same securities in larger sizes.
Government bonds are more accessible. Through TreasuryDirect, you can buy Treasuries at auction with a non-competitive bid — meaning you accept the yield the auction sets — for amounts up to $10 million per auction, and Treasury fills all non-competitive bids before addressing competitive ones.11TreasuryDirect. How Auctions Work There’s no bid-ask spread, no broker markup, and no minimum beyond the security’s face value.
Private Credit Funds
Private credit funds lend directly to middle-market companies that are too small or too complex for the public bond market. These funds typically take the form of limited partnerships with multi-year lock-ups, so you can’t easily access your capital. Minimums commonly start at $250,000 or more. In exchange for that illiquidity, private credit tends to pay higher yields than comparably rated public bonds.
Access is restricted to accredited investors. Under SEC rules, that means an individual with a net worth exceeding $1 million (excluding a primary residence) or annual income above $200,000 ($300,000 with a spouse) for the prior two years.12U.S. Securities and Exchange Commission. Accredited Investors Holders of certain professional licenses and certifications also qualify.
How the Income Is Taxed
Interest payments from corporate bonds, leveraged loans, and most other taxable credit instruments are treated as ordinary income, taxed at your marginal federal rate, with state and local income taxes on top in most places. Treasury interest is a partial exception: federal tax applies, but state and local don’t.4Internal Revenue Service. About Tax Topic 403 Interest Received
Municipal bond interest gets the most favorable treatment. It’s generally exempt from federal income tax and, for in-state bonds, often exempt from state and local taxes too.6Municipal Securities Rulemaking Board. Municipal Bond Basics Comparing a muni yield to a corporate yield head-to-head is misleading; use the tax-equivalent yield.
Sales before maturity work like other capital assets. Sell for more than you paid and the profit is generally a capital gain, long-term if held over a year, short-term if not. Sell at a loss and you can offset other capital gains. Bonds bought at a deep discount can have a portion of gain treated as ordinary income rather than capital gains, so the math around discount bonds is worth reviewing with a tax professional before you sell.