Bonds are viewed as a safe investment, particularly for retirees, but bonds aren’t entirely risk-free especially those for companies or municipalities, nonetheless, US treasuries remain a safe bet. Here are the basics of bonds.
Let’s look at the core basics you need to know about bonds: What they are, how they pay interest, how they are affected by interest rates, and the types of bonds. We’ll also cover how they are rated, which are safest, and why you should consider bonds.
Simply put, a bond is a loan made from the investor to the bond issuer in return for the principal amount plus interest.
A bond pays interest on an annual percentage rate of its face value. For example, a $1000 bond with a five 5% semiannual coupon pays $50 of interest every year in two $25 installments until maturity, according to US News & World Report.
A bond maturity is how long the investor will receive interest payments. A short-term bond is between 1-5 years. An intermediate-term bond is 5-12 years, and long-term bonds spanned 12-30 years, according to Investopedia.
Interest rates rise and fall, however, there is a greater probability they will go up within a longer time period, than a shorter period.
If you purchase an intermediate or long-term bond and interest rates go up, your money is tied up on bonds paying a lower rate of return. To get out of these investments, investors sell the older bonds with lower rates, at a price below face value, as these are already less attractive to investors.
Because of this, investors who buy long-term bonds attempt to sell them before maturity.
Generally, people purchase bonds because they are a fairly stable stream of income. Compared to stocks, they are low risk. The coupon payments of a bond are guaranteed, so an investor knows how much they will receive and when.
“High quality bonds,” such as US government bonds or high-grade corporate bonds are considered the safest bond investments. It takes a rare occurrence for bonds to fall, such as the 2008 global financial crisis.
For those who can’t take a huge risk when it comes to investing, but want to earn some interest on their money, bonds are considered a fairly safe bet.
The amount of interest paid on checking and savings accounts now is a fraction of what it was in the past. Having your money sitting in the bank allowing the bank to earn interest off your money while you receive little to nothing in return is a bad strategy. Most experts advise it is better to invest some of your money in bonds rather than having it sit in a checking or savings account.
Treasury Bonds: bonds issued by the US government are called U.S. Treasury Bonds. And assets very unlikely the US government will default on it debt, these T-Bills are considered among the safest investments available.
Corporate bonds: These are bonds issued by private and public companies, starting at $1000 with varying coupon (interest) rates and maturities (length of term).
To determine which of these bonds are the safest best, there are credit rating agencies that use a system of scales by companies such as Moody’s, Standard & Poor’s, and Fitch Ratings, all of which rate bonds based on their overall risk, assessing the issuers’ creditworthiness, (the likelihood they’ll repay the investor).