There are many ways to go when investing: stocks, bonds, and mutual funds. Many people think that they can’t support them because they don’t understand all these things or work together. That’s where bonds come into play.
Bonds are different from stocks because you are loaning money to a company versus owning stock which means that if the company does well, you will earn dividends based on the number of shares you own. Still, if the company does poorly or goes bankrupt, your investment is lost, whereas, with a bond, you will be paid back by the corporation at a particular time in the future for the loaned amount plus an interest rate.
Investors buy bonds to get a predictable return over a certain period. Bonds typically pay interest every six months, and the investor is guaranteed to get all of their money back when the bond matures, which is when it reaches its predetermined date.
Bonds can be bought in many different ways: at your bank, through your broker or your financial planner if you have one.
The most important thing is to understand the different types of bonds and how they work before investing your money.
Government Bonds
Governments issue government bonds to finance their operations. They offer a low-risk investment since the government is unlikely to default on its debt. However, government bonds typically offer a lower return than other bonds.
Municipal Bonds
Cities, counties issue municipal bonds and other local governments to finance public projects such as infrastructure improvements and school construction. They offer a higher yield than government bonds, but they also carry more risk because the municipality could default on its debt.
Corporate Bonds
Companies issue corporate bonds to finance their operations. They offer a higher yield than government bonds, but they also carry more risk because the company could default on its debt.
Junk Bonds
Companies issue junk bonds with a weak credit rating. They offer a high yield, but they also carry an increased risk of default.
International Bonds
Governments or companies in other countries issue international bonds. They offer a higher yield than domestic bonds, but they also carry more risk because of the potential for political and economic instability in other countries.
Zero-Coupon Bonds
Zero-coupon bonds are bonds that don’t pay interest. Instead, they are sold at a discount, and the investor receives the bond’s total face value when it matures.
Convertible Bonds
You can convert convertible bonds into shares of the company’s stock. They offer a higher yield than regular corporate bonds, but they also carry more risk because the stock could decline in value.
TIPS
TIPS (Treasury Inflation-Protected Securities) are Treasury bonds designed to protect investors from inflation. The principal of TIPS is adjusted based on changes in the Consumer Price Index, and the interest payments are also adjusted for inflation.
Callable Bonds
Companies issue callable bonds with the option of calling back the bond from the investor. For example, a company may issue a five-year bond callable after three years. If interest rates fall during that time, the company will call back the bond and reissue it at a lower rate. The investor must then reinvest in a new bond at current interest rates. It results in lower returns for the investor, reducing risk because he doesn’t have to wait five years to mature his investment.
Zero-Percent COUPONs (ZCs)
A zero percent coupon means you pay 100% of face value today and receive no interest payments until maturity. Issuers created these as a way to finance debt with long-term maturities.
Bottom line
Each type of bond has its own set of benefits and drawbacks, so it’s essential to understand the different types before you invest your money. By understanding the different types of bonds available, you can find a suitable investment for your needs.