Investing in Bonds
Very few people discuss in depth the specific things in which you can invest those funds that you have so carefully squirreled away for the important day that is to come in the dark dank future that seems as though it will never arrive.
Bonds are not your typical high risk-high yield investment but they are very likely to earn a return for you. When considering a bond investment strategy, remember the importance of diversification. As a general rule, it’s never a good idea to put all your assets and all your risk in a single asset class or investment.
There are essentially three different types of bonds: corporate, municipal, and government.
Corporate Bonds:
A company can issue bonds just as it can issue stock. Large corporations have a lot of flexibility as to how much debt they can issue: the limit is whatever the market will bear. Generally, a short-term corporate bond is less than five years; intermediate is five to 12 years, and long term is over 12 years.
Corporate bonds are characterized by higher yields because there is a higher risk of a company defaulting than a government. The upside is that they can also be the most rewarding fixed-income investments because of the risk the investor must take on. The company’s credit quality is very important: the higher the quality, the lower the interest rate the investor receives.
Municipal Bonds:
Municipal bonds, known as “munis”, are the next progression in terms of risk. Cities don’t go bankrupt that often, but it can happen. The major advantage to munis is that the returns are free from federal tax.
Furthermore, local governments will sometimes make their debt non-taxable for residents, thus making some municipal bonds completely tax free. Because of these tax savings, the yield on munis is usually lower than that of a taxable bond. Depending on your personal situation, a muni can be a great investment on an after-tax
basis.
Government Bonds:
In general, fixed-income securities are classified according to the length of time before maturity. These are the three main categories:
Bills – debt securities maturing in less than one year.
Notes – debt securities maturing in one to 10 years.
Bonds – debt securities maturing in more than 10 years.
Marketable securities from the U.S. government – known collectively as Treasuries – follow this guideline and are issued as Treasury bonds, Treasury notes and Treasury bills (T-bills). Technically speaking, T-bills aren’t bonds because of their short maturity. (You can read more about T-bills in our Money Market tutorial.) All debt issued by Uncle Sam is regarded as extremely safe, as is the debt of any stable country. The debt of many developing countries, however, does carry substantial risk. Like companies, countries can default on payments.
You should really carefully consider whether or not bond investing is a good idea of your retirement needs along with your nerves. We weren’t all born with nerves of steal, for this reason it is probably a good idea to carefully decide whether or not you are comfortable with the risks that bonds introduce into your investment picture.
I always recommend that you take the time to discuss your plans and goals with a financial planner before taking the plunge and making any major financial decisions whether they concern your retirement or your child’s college fund. These all affect your future and the security you can provide your family when the time comes. A good financial adviser can help you weigh the pros and cons of investing in bonds and help you decide whether or not the potential payout on these bonds is worth the risks that are involved in the process. This is not the case for everyone. I tend to be a more cautious investor than most and will think long and hard before investing on things that I do not consider a carefully crafted and calculated risk.
Related posts: