Investing in Bonds 101

Another popular investment option amongst consumers is to purchase bonds. When an investor purchases a bond, they are purchasing portions of ownership for a company. 

 

 

 

 

 

However, this should not be mistaken for stocks.Bonds are an investment into a company through debt obligation. This means that when you purchase a bond, you are actually loaning the money to the business, government or other organization selling the bond. In exchange for helping an organization by purchasing a bond, they promise to pay back the bond with a predetermined period of interest added to the original price.

Bonds are in incredibly effective way for large organizations such as companies and federal and local governments to raise money. For example, businesses commonly sell bonds as a way to fund projects, hire new talent, purchase property or handle other business operating costs. When the government sells a bond, they are usually using the capital to fund projects with infrastructure, like repairing or building roads and schools, and supporting military needs. These agencies and organizations use bonds as a way to get the money they need for jobs or tasks that may cost more than the money an average bank can supply. However, there are some risks to bonds that all investors should know before purchasing.

How do bonds work?

Whenever a consumer purchases a bond from a government or corporation, they agree to loan the entity money for an established period of time. The specified date where a bond must be paid back is typically referred to as the “maturity date” of the bond. The original amount of money that the consumer loaned out in the bond is referred to as the “face value” and must be paid back on the maturity date.

Before the maturity date of the bond, the borrower will pay the interest of the bond to the consumer in the form of routine payments at an agreed-upon schedule and rate. The interest payments that is paid on a bond is typically referred to as a “coupon” or “yield”. One thing about bonds is that the issuing price is generally at a fixed rate while the actual market value of the bonds may rise or fall before the maturity date. A bond’s market price may be below or above its face level depending on a variety of factors such as the lender’s credit and interest rates.

What are the different types of bonds?

When considering investing in bonds, there are a variety of types of bonds that can be issued by different types of issuers. Some of the most common types of bonds available include:

  • Government bonds – These bonds are issued by the national and low-level governments in the United States. U.S. government bonds are sometimes referred to as treasuries and they tend to be some of the safest types of government bonds. State and local bonds are also safe, but they are less guaranteed than federal bonds.
  • Corporate bonds – Corporate bonds are typically issued by companies in order to fund projects, expansions and other business expenses.
  • Asset-backed securities – Asset-backed securities (ABS) are bonds that are issued directly from financial institutions such as banks. These types of securities are backed by financial assets such as credit card receivables, auto loans and home equity loans.
  • Mortgage-backed securities – These securities are similar to asset-backed securities, except they are primarily backed by home mortgages instead of other financial assets.

What are the benefits of investing in bonds?

Investors who are looking to include bonds in their financial portfolio can take advantage of the numerous advantages of bonds. One of the biggest advantages is that bonds are less volatile and risky then stocks, making them low-risk investments. When an investor purchases bonds, they are essentially purchasing debt with a company. While this is less likely to turn a profit than buying equity in a company, consumers who purchase bonds are more likely to have a secure investment. This is primarily because investors who purchase bonds will be first to receive a payout if a company goes bankrupt.

Investors looking for a safe, steady and dependable source of income may prefer to purchase bonds. Bonds allow them to have a more predictable income from their investment compared to stocks. Many investors purchase bonds as retirees so that they can live off of their investment interest. In many cases, investors will earn more interest on bonds than they would by simply depositing their money into a savings account. Bonds allow investors to invest their money long-term while still receiving financial returns.

Beginning investors are encouraged to add diversity to their investment portfolio by investing into a variety of stocks and bonds. Bonds issued by state and local governments are called municipal bonds and provide interest payments that are exempt from any federal taxes. In some cases, bonds made to state or local government may also be exempt from local taxes.

What are the disadvantages of investing in bonds?

Although bonds are generally a safer investment that stocks, there are still a few risks and disadvantages that investors should consider. For example, the low-risk nature of bonds also means that they have a lower rate of financial return than other investments. Investors looking to grow their finances substantially may not have much luck when investing in bonds. Furthermore, the interest rate and face price of a bond are usually established when the bond is created.

However, a bond’s market price is based on the credit rating of the lender. This means that investors who try to sell their bonds before their maturity date may have to sell the bonds at a lower value than the face price. Although there are a few disadvantages to investing in bonds, they are typically a safe and reliable way to invest. Bonds can help an investor to diversify their financial portfolio and they can also be a good source of finances. Retirees can make great use of bonds so that they can live off of the interest payments until the bonds’ maturity dates. As investors near retirement, they should consider investing in bonds.