From Junk to U.S. - Bonds, That Is.


Series: Saving and Investing	Page 1 of 2
From Junk to U.S., Bonds That Is Terms of Use:

You may know Barry Bonds or James Bond, but do you know about investing in bonds?

Bonds are loans you make to the federal, state, city or county government or to corporations. Bonds are repaid to you at a promised future date and you earn interest on them. You can think of them as similar in some ways to a Certificate of Deposit (CD) or share certificate.

Like a certificate, you buy a bond at a certain price (its principal) and at the end of a certain time (the maturity date) you collect your principal along with an agreed amount of interest.

There are four types of bonds you should know about: Government, Corporate, Municipal and High-Yield (or junk) Bonds.

Government bonds (often called Treasury Securities) are the safest bond investment because they are backed by the "full faith and credit" of the U.S. government.

If a business or city goes bankrupt, you may have trouble collecting your bond. That is not likely to be the case with the government.

Bonds are considered a "fixed income" investment because they provide you with a stream of income in the form of interest payments (usually paid twice a year) until the maturity date. A lot of investors, especially middle-aged and elderly investors, rely on this income.

Before jumping into the bond market, you should consider the safety, term (length of time until maturity) and interest rate of each bond type.

In addition, there are different tax advantages with different bonds. Small investors can buy U.S. Savings Bonds for as little as $25. These bonds are exempt from state and local taxes, and you don’t pay federal taxes until you redeem them.

U.S. government bonds are classified by the length of time it takes them to mature. Treasury Bills (T-bills) mature within a year; Treasury Notes (T-notes) take one to ten years, and Treasury Bonds (T-bonds) take more than ten years. T-bills, T-notes and T-bonds all cost a minimum of $1,000.

You buy T-Bills for less than their face value and when they mature, the government pays you the face value.

For example, you buy a 90-day $10,000 T-Bill for $9,750. Three months later you collect $10,000 (earning $250 interest).

There are two kinds of T-notes and T-bonds. With a fixed principal U.S. bond, you are paid a fixed interest rate twice a year until the bond matures. Then you get paid back your principal or par value, also referred to as the face value or maturity value.

With inflation-indexed T-notes and T-bonds, both your interest payments and your final principal payments are adjusted for inflation. The inflation-indexed ones have a lower interest rate than the fixed principal kind.

Series: Saving and Investing	Page 2 of 2
From Junk to U.S., Bonds That Is Terms of Use:

New T-bills, T-notes and T-bonds are sold every week in auctions with prices often determined by big investors who buy in quantity. Individual investors can buy government bonds via the internet, by phone or by mail. Check with your financial institution, broker or online at TreasuryDirect municipal bond (also called a muni) can be sold by a city, state, or county and have terms of between 1 and 40 years. Munis are tax-free on the federal level and usually also to residents who buy munis from their own states. This means if you buy munis from your local governments, you don’t pay taxes on the interest earned.

Some employers even offer savings bonds through automatic payroll deduction, meaning you can start saving before your paycheck gets spent on other things.

The owner of a U.S. savings bond cannot sell or transfer it to someone else. T-bills, T-notes and T-bonds are different from U.S. savings bonds in that they can be sold by their owners in the securities market. That is why they are sometimes referred to as "marketable securities."

You may read in the paper that your city is issuing a $10 million bond issue for road improvements. First, the people will vote to raise taxes. Then the city will sell $10 million worth of bonds to investors, usually starting at $1,000.

The city will use the bond money to build roads, and pay the investors back over a fixed time period with tax money.

In another example, money earned from a new football stadium (instead of taxes) can pay back the bond issue that built it.

A corporate bond is fully taxable, but often pays more interest than munis or T-bills.

There are debt-rating companies like Standard and Poor’s and Moody's that rate bond issues based on their estimation of the likelihood you'll get repaid. AAA bonds are the best, AA is next best, all the way down to D.

Anything rated BB or lower is classified a junk bond and probably a risky investment. However, junk bonds usually pay three to four percent higher interest than safer bonds, so they are also called high yield bonds.