Almost everyone, whether or not they are investors, knows about the stock market and some simple things about investing in equity. However, by and large, there is very little public knowledge, especially among financial investment newcomers about the massive bond market that is largely ruled by the government, companies, financial institutions, and a large number of brokers.
In simple terms, bonds are a type of debt investment that involves investors lending money to the issuer of the bond in exchange for interest payments at pre-determined intervals. Investing in bonds is among the most significant options for those who attempt to generate enough income through interest to meet their investment objectives. Typically, retail investors of bonds can invest in instruments that are issued by companies, municipalities or even the government treasury. The large choice makes it necessary for investors to know the characteristics of different types of bonds so that they are in a better position to evaluate the benefits and hazards associated with each.
Different Types of Bonds Available for Investment
The types of bonds that you can invest in are quite diverse and so are the ways that you can hold them. While there are no clear advantages with anyone that dominates over the rest, experts suggest that conservative investors should have at least a quarter of their portfolio invested in bonds that are rock-solid. Some of the more common types of bonds examined:
Corporate bonds: These bonds are issued by companies that are looking to raise funds without diluting their equity. Corporate bonds typically offer higher rates of interest or yields than those issued by governments and are quite suitable for including in the portfolio of high net worth investors who are conservative. Investors who are in the high tax bracket often prefer to buy these types of bonds in tax shelters like rollover Individual Retirement Accounts. The more reputed the company, the lower will be the yields due to the extra security.
Municipal bonds: Municipal bonds are typically issued by local governments to finance their public infrastructure like roads, bridges, schools, hospitals, etc. Even though normally the interest rates tend to be low due to the safe nature of the investment, the actual yield of these bonds goes up as often they are exempt from taxes, federal, state and local, which makes them very attractive to investors in high-income tax brackets, according to a nationaldebtreliefprograms.com counselor.
US Savings Bonds: These bonds are issued by the Department of Treasury of the U.S. government to finance the government’s spending on national requirements. According to https://www.forbes.com, the market in U.S government bonds exceeds $41 trillion. They are the safest kind of securities as they are backed by the reputation and credit of the government and are highly unlikely to ever fail. The Series EE Savings Bonds, which is one of the most popular Savings bonds not only offers a fixed rate of interest for up to 30 years, it also allows investors to use the interest in funding college education for any member of their families without having to pay income tax. While the maturity periods vary, there is a minimum holding period of 12 months. The Series I-Bonds have a combination of fixed and variable rates of interest; while the fixed rate is set when it is bought, the variable rate is adjusted every six months based on the consumer price inflation rate.
Bond Funds: Many people who prefer not to get involved in the details of the bonds can instead, invest in bond funds, which is a special type of a mutual fund that invests only in bonds. Investors can invest smaller sums of money than that possible while directly buying bonds; they get a better diversification for safety and also get the benefit of professional fund management. Bond funds make money management far easier for those who would not like to get bogged down with the paperwork required to track a multitude of different bonds in the portfolio.
Junk Bonds: Often marketed in a very enticing form, junk bonds usually promise very attractive returns. However, since these bonds are not backed by solid assets, they can easily default when the economy slows down or the issuing company goes bankrupt due to mismanagement or environmental factors. Unless you are an investor with a very high-risk profile, it is usually better for you to stick to investment grade bonds.
Why Invest in Bonds
Bonds have always been considered as a safer investment for long-term savings than the stock market. Among the more significant advantages of investing in bonds is that they offer a very reliable stream of cash even in times when the rate of interest is comparatively low. A well-diversified portfolio with a significant bond component can provide yields that are relatively decent with a level of volatility that is far less than that of equities and more income than bank instruments and money market funds. This makes bonds very important for those who rely on interest income. Bonds also help to diversify the investment portfolio to provide returns to investors that are better adjusted for risk and thus are important in the preservation of capital when the stock market is tumbling.
Fixed income investments like bonds are very useful and important for people who are nearing the time when they will need to access the principal amount invested. Investing in the bond market will ensure that the principal does not show any erosion as compared to the stock markets that can undergo very wide swings in relatively little time without much advance warning. This assurance of safety often results in investors moving from the equity market to the bond market as they near their financial goals. While income from most investments is taxable, there are some bonds on which the interest income is completely tax-free like municipal bonds and U.S. Treasury bonds. This can make the yields very attractive to investors in high-income tax brackets.
For many people, bonds lack the glamour of equities, however, for those who are money wise and interested in building a balanced and diversified portfolio, bonds represent an extremely viable and safe investment.