Smart Saving and Investing

So what are Bonds anyway?

Bonds represent a loan. For example, if you lend the U.S. government some cash in the form of a U.S. Government Bond for the amount of $xxx.xx, they will promise to pay you $x,xxx.xx sometime in the future as determined by the bond.

There are a variety of Bond types that come from various issuers. An issuer is an entity. An entity is a…, well you get the point, I hope. Issuers include the U.S. government, state and local governments, and corporations.

Bonds create a balance in our portfolios and are typically viewed as a conservative investment. Bonds tend to provide you with a steady stream of income and react differently to how stocks react to market conditions.

A lot of investment pros will tell you, “When interest rates go up, the value of bonds go down.” Likewise, “When interest rates go down, the value of bonds go up.” We’ll discuss this in a future article for this series on “All About Bonds.”

Depending on what makes you sleep at night or how you handle watching the markets go sky high one day and fall to earth hell another day, helps you determine if and when you should invest in Bonds.

Through years of investing, I wouldn’t look at bonds until you’re 50 years or older because prior to that age, you should be in the growth stage of investing by way of Mutual Funds, that is, stock mutual funds or what they also call equity mutual funds.

As a reminder, this site promotes three actions, open and contribute monthly and automatically to an online saving account paying 5.05% at the current time, 2007. Participate in your employer’s retirement plan and open and invest in a Roth IRA. See the About page for what context I’m writing in.

Ok, back to bonds. Here’s a quick list of bond types.

U.S. Government Bonds include:

• Treasury Bills
• Treasury Notes
• Treasury Bonds
• Savings Bonds
• Treasury Inflation-Protected Securities
• Agency Securities

Government bonds are considered the lowest risk and safest of bonds because they are backed by the United States government.

Municipal Bonds (”munies”) include:

• General and
• Revenue

They provide for state and local governments to fund projects like building stuff - roads, bridges, etc. These are attractive to high tax bracket folks because they are except from federal income tax on the interest the bonds pay. As an added benefit, if the municipal bond is withing your state, it could be exempt from state and local income tax.

Our good and well respected friend Suze Orman invests in Municipal Bond:

What does Orman do with the rest of her money? Solomon asked, and was told: “Save it and build it in municipal bonds. I buy zero-coupon municipal bonds, and all the bonds I buy are triple-A-rated and insured so that even if the city goes under, I get my money. I take a little lower interest rate to make sure my bonds are 100 percent safe and sound. “ Source

Corporate Bonds include, well:

• Corporate Bonds Companies can finance many different projects by way of Corporate Bonds. These are considered the more higher risk bonds.

That’s it for the types of bonds we’ll discuss in this post.

A great resource for U.S. Government Bonds is the website Treasury Direct. This site is also helpful for folks who might have parents who have passed away and held EE Bonds from years ago. You can find out what they are worth by entering the bond serial number and issue date at the website. This is something I had to do this year.

To end, here is a fund for those folks who can’t stomach or don’t want to stomach the huge swings in the market. The fund is the T. Rowe Price Capital Appreciation fund, symbol PRWCX. It holds approximately 50% stock and 50% bonds. The fund has never had a down year in the last 10 years. It has averaged 12+% the last 5 and 10 years time horizon.

For the indexers out there here is an index bond fund.  The Vanguard Total Bond Market Index, symbol VBMFX.

written by Bill Stevens