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One of the more popular investment vehicles these days is the bond. Bonds are becoming popular because they are seen as “safe” investments. And at a time when people are concerned about preserving their capital, bonds can seem like a good idea. I agree that bonds can be a useful part of your investment portfolio, but I also think that panicking and avoiding stocks and other investments altogether is a bad idea. Try to approach asset allocation with long-term goals in mind, and use bonds as part of an overall investing strategy.

The basics of bonds: Treasury, Corporate and Municipal

When investing in bonds, it is a good idea to understand how they work. First of all, bonds represent debt. You are essentially making a loan to an entity. You will be paid a certain rate of interest for the loan, which you can collect regularly. When the term of the loan is up, you are repaid the full face value of the bond. There are three main types of bonds, and TheSUBWAY explains what they are:

Treasury bonds, also known as “T-bonds” for short, are issued by the United States government and are considered to be the safest of the three bonds.  The only risk is if they are sold prior to maturity (but this holds true for all bonds). Super-safety comes at a cost, though, and in the case of treasury bonds that means lower returns than other bonds. …

Corporate bonds are issued by companies in order to raise capital.  While they can be very safe investments when issued by strong, established companies, the reverse is true for companies that are not rock solid. Unlike treasury bonds, corporate bonds have what is known as a “call provision”, which allows the bond holder to get their principle investment back before maturity.

Most corporate bonds have fixed interest rates, and some, called “zero coupons” are sold at a significant discount in exchange for the bondholder agreeing to wait until maturity to receive interest payments. …

Municipal bonds are issued by state, county, or city governments for the purpose of financing government sponsored functions (I.E., building a highway or a school), or for other “non governmental” purposes, such as raising money for low income housing or student loans.

Municipal bonds, like T-bonds, pay interest twice a year.  These investments can be very safe, but do carry risks as well. Moody’s and Standard & Poor rate municipal bonds based on their credit quality, so when investing in them, it’s a very good idea to use these ratings as a guideline.

Depending on whether you sell in the secondary market, or whether there is a chance of default, different bonds have different risks. Carefully evaluate your situation and goals to figure out which bonds are best for your investment portfolio.

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