Investing can provide financial security at all stages of life and diversified investing reduces the risks of loss. Not only does spreading investment types such as stocks, cash instruments and bonds but diversifying investments in types bond as an instrument of choice is also a good idea.. Bonds are considered safer than stocks but there are still risks involved including interest rate, credit, liquidity and call risk. Taking the advice of a financial professional will increase the probability of successful investing but learning about bonds can help you make sound decisions when investing. It is always wise to learn about bonds and get detailed information before deciding to invest. First establish an clear understanding of what bonds are, the risks involved, the goal of your investment strategy and your tax situation to assess the advantages and disadvantages of different types of bonds.
Different Types of Bonds
When you purchase a bond, you in fact become a lender. As a lender, you collect interest until the loan is paid off. The bond is the promise to pay. You may be lending to the Federal Government by buying or investing Treasury Bonds, a city with Municipal Bonds, Corporate Bonds or in high yield Junk Bonds. All bonds have definite maturity dates, a yield or return on investment, a credit rating based on the likelihood that the borrower will repay the debt, and the coupon rate or interest that you will collect for the life of the bond which may be taxable or tax exempt. You can also invest in Bond Funds, which is a diversified portfolio of bonds. There are also different types of bond funds with different characteristics and objectives.
Treasury Bonds
Treasury bonds include T Bills that mature in up to a year, T Notes that mature between 2 and 10 years, T Bonds that mature 20 to 30 years and TIPS (Treasury Inflation Protected Securities that protects their value from the inflation index.
Municipal Bonds
Municipal bonds and municipal bond funds may be issued to fund city buildings, highways, parks and other public projects and may be issued by cities, states or public utilities. They typically are low yield compared to corporate bonds but tax free status can increase their value to the investor and creates a tax equivalent yield.
Corporate Bonds may be issued to raise capital for project or expansion. The corporation can issue shares of stocks or bonds. You as a lender will collect the interest and receive you loan amount at the maturity of the bond.
Junk or High Yield Bonds
The higher yield of junk bonds come with the higher risk of default on the loan which results in the borrower paying a higher interest rate. The high yield the investor receives is compensation for the higher risk. Investing in junk bonds is wise at the end of economic recessions because because the prices increase as the economy improves.
Bond Funds
Buying a bond fund is buying shares in a portfolio of bonds with a particular goal such as to increase current income, total return or to match the performance of a market index. The investments may be in a certain type of bond or a particular rage of maturity. The price of the bond fund is based on the Net Asset Value (NAV) which is the total market value of the portfolio divided by the outstanding share and can changes daily with the market conditions or cash flow. Funds can be actively managed, indexed, open or closed end, exchange traded funds (ETFs) or unit investment trusts. Taking the time to learn the different types of bond funds and selecting the right one for you should also come under the advice of a financial professional for best results.
Important Consideration When Investing In Bonds
After becoming familiar with the different types of bond, becoming informed about other considerations is also merited. Having the advantage of a financial professional, such as a financial adviser, broker, or account executive, is always a wise decision but having the knowledge to make sound judgment calls can be invaluable. Assessing risk, choosing maturity options, yield and redemption features can all affect your investment decision. Taking these and other bond features into consideration will help you navigate your options with greater levels of financial success.
Risk Factors
Price, interest rate, yield, maturity and tax status may be the most important consideration for some investors. Price includes interest rate and credit quality and the interest rate can affect the yield. The current yield is the annual return on the amount paid and figured by dividing the bond’s interest payment by that amount. Yield to maturity is all the interest receive and any gain or loss until the bond matures. There is also yield to call is the return received by holding the bond until it is paid off before the maturity date. The market conditions will cause the bond to fluctuate and its value may become higher or lower if you decide to sell it before it matures. Default occurs if the bond issuer or borrower fail to pay the interest or principal when due, fail to report as required or other problems occur such as bankruptcy. Bonds are secured if backed by collateral, unsecured or senior bonds which take priority in claims over subordinate bonds that offer higher interest rates.
Tax Considerations
The tax status of bonds can make them more attractive. US Treasury bonds are exempt from state and local tax. Municipal Bods may be exempt from federal, state and local tax. If the bond are in a pension, IRA or 401 (k) account and taxes is deferred the bond holder will not have the advantages offered by their tax exempt status.
Strategies to Achieve Financial Goals
Bonds can be a good investment in achieving your financial goals by providing a steady stream of income that can tax free, help to achieve a future purchase or to be used to meet current living expenses. Diversification helps reduce the risk of loss and bonds offer options for diversifying. Bonds offer the opportunity to maximize you present income by investing to enjoy the benefits later. Your investment goals, horizon and risk tolerance will all play a part in your investment choices. This discussion about investing in bonds is not comprehensive but can guide you to topics to become more knowledgeable about when deciding to invest.