In part one of this series on All About Bonds, you read about three main types of Bonds – U.S. Government Bonds, Municipal Bonds and Corporate Bonds.
You were also introduced to a fund that holds approximately 50% stocks and 50% bonds, called the T. Rowe Price Capital Appreciation fund, symbol PRWCX. You also read about an index bond fund called the Vanguard Total Bond Market Index, symbol VBMFX.
You can participate in bonds by owning Bond Funds and not purchasing bonds individually just like you can participate in stocks by owning Mutual Funds instead of buying and selling individual stocks.
Interest rates play a big role in how bonds perform. So much so, that interest rates drive the bond market. You might have heard before, “When interest rates go up, bond prices go down and when rates go down, bond prices go up.”
As the S&P 500 is used to compare returns of a mutual fund, the 10-year treasury note has become the standard measuring stick for bonds for some folks.
There are many investment “Grades” when it comes to bonds. Grades include the following:
- Highest Grade – AAA – these bonds carry the smallest amount of risk and are the safest
- High Grade – AA – very small amount of risk but not as good as AAA
- Upper Medium Grade – A – still a very small amount of risk but might be sensitive to adverse economic changes
- Medium Grade – B – these are still acceptable bonds but might be sensitive to adverse economic changes
There are many grades but we don’t want to go below “B” grade.
As you compare buying bonds individually to buying stocks individually, you find that you would watch some of the same attributes of stocks as you do bonds. Some of those attributes include:
- Risk – there is some risk with bonds even though they are considered safer than stocks
- Bond Market
- Trading Bonds
- Tax Issues
- Interest Rates
- Capital Gains and Losses
- Economic Indicators
With all the above similarities as stocks, you might consider pursuing Bond Funds instead of owning Bonds outright.
The final Part 3 of this bond series will discuss Bond Funds and Bond Strategies.