ABCs of Investing

Interest payments occur when you lend someone money and they pay back more than they borrowed.  For example, when you deposit money into a high interest savings account, then the bank will give you interest payments for lending them the money.  (Note: interest payments also occur when you borrow money, but then you pay interest to the lender.)

An example interest payment

Bob buys a 10 year $1,000 bond from company XQY which pays a 5% interest payment per year payable at the end of each year.  Bob will receive a $50 interest payment each year for 10 years. At this point he will also get back his original $1,000 investment.   If Bob is holding this investment in a taxable account then he will have to declare the interest payment of $50 on his income tax form each year.  If the investment account is non-taxable account like a 401k plan, then he doesn’t have to worry about the taxes.

If your portfolio contains some sort of fixed income, then you will receive interest payments from that investment.   Examples of such investments could be bonds, certificates of deposits, mutual funds or exchange traded funds.  It is not always obvious when you are getting interest payments – if you buy a mutual fund that is balanced fund (contains bonds and stocks) then some of the dividends received from the fund will be from interest payments.  It is also possible for a stock mutual fund to pay some interest because it can earn interest on any cash it holds.