All About Bonds – Part 1

This article is the first in a series:
All About Bonds – Part 2
All About Bonds – Part 3

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.”

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

If you like to invest conservatively you might want to invest in bonds only. There are bond funds that allow you to participate in bonds as an investment. Instead of buying and selling bonds directly you could buy a bond fund that manages the details of buying and selling bonds.

Other investors might invest more aggressively throughout their life with stock mutual funds prior to age 50 and then start investing in bond funds as a way to preserve their investments as they get closer to their retirement age.

As a reminder, this site promotes three actions for most people who work for a living for the majority of their lives:

1. Open an online saving account
2. Participate in your employer’s retirement plan and…
3. Open and invest in a Roth IRA

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 exempt from federal income tax on the interest the bonds pay. As an added benefit, if the municipal bond is within your state, it could be exempt from state and local income tax.

A popular and wealthy, saving and investing teacher invests in Municipal Bonds.  This person buys zero-coupon municipal bonds, and all the bonds are triple-A-rated and insured so that even if the city goes under, this person gets their money. She takes a little lower interest rate to make sure the bonds are 100 percent safe and sound.

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.