August 29, 2019
The investment world is dynamic, from stocks to ETFs, index funds to mutual funds, and CDs to bonds, there are plenty of options. And this diversity often confuses the investor. It becomes difficult to decide which investment option is better and has a higher ROI than others. While there is some level of risk attached to most of the investment methods, bonds are a rather safe option on the risk ladder.
Essentially, bonds are loans from an investor to large organizations, such as corporations, cities, or the government. The investor lends the money to any of these organizations and receives payment at a fixed rate of return at scheduled intervals. Hence, bonds are a means of “fixed income security” and a safe way to invest in your future.
Investing in bonds not only guarantees a payback with interest, but also helps diversification in an investor’s portfolio. It is always good to have some investments in bonds as they help to balance out the risks. You never know when the stock markets may crash. Hence, bonds can help survive through such a crisis.
The borrowing body agrees to pay the bond back at a pre-determined date. Until the bond matures, the bondholder gets interest-payments at regular intervals. The bond owners are the creditors or the debt holders who have to pay the face value, i.e., the principal at the maturity date. Most bondholders prefer to resell their bonds in a secondary market. So, either the bonds get traded publicly on exchanges or it may be a private affair between a broker and creditor.
Before discussing the types of bonds, and how they work, let’s go through some basic characteristics of bonds for a better understanding.
There are many types of bonds available in the market concerning the issuer, maturity length, interest rate, and risk involved.
The Treasury Department of the US government issues bills, notes, and, bonds, also called Treasuries. Since the government backs these bonds, they are the safest, marketable bonds with little risk of default. Further, T-bonds make payments semiannually, while the income is taxed only at the federal level.
The treasury department auctions the T-bonds for funding the federal government’s operations. You may directly buy T-bonds from the Treasury Department, or a broker in about $100 increments. The T-bonds mature for 10 to 30 years.
Various cities and localities issue tax-free Municipal Bonds. These bonds have low-interest rates compared to other types of bonds. Also, municipal bonds are risky to invest as city governments do default occasionally.
Like the T-bonds, municipal bonds are also marketable; hence, the bond’s price changes. However, the interest rate and ROI don’t ever change if the investor holds on to the bond. You can buy municipal bonds through a financial advisor, a bank, directly from the municipal, or a bond fund.
Corporate bonds are the bonds issued by different companies. They involve more risk than T-bonds, and therefore, offer higher return rates. There are three types of corporate bonds that representative banks sell.
Like the other ways of investment, bonds also have some benefits to offer along with some risk factors. Let’s discuss each of them separately.
The treasury bonds are the safest as the US government backs them. These risk-free bonds are only taxed at the federal level.
Bonds have varying maturity periods ranging from one year to 30 years. You may either hold the bond until it matures or resell the bond in the secondary market.
You may buy a bond from an online broker, or an investment bank in an initial bond offering. Also, you may purchase a bond through an exchange-traded-fund or directly from the US treasury department.
The bond market may seem slightly complex to you, and you may dread to invest your money in bonds. However, the bond market works on similar lines to the stock market. Also, it involves risk and returns on tradeoffs of similar magnitude. Don’t get overwhelmed; take the first step, and dive into the pool. You will eventually learn to swim across and unmask the dynamics of the bond market.