Government & Corporate Bonds Investment

Most people know about the basics of investing in the stock market but many people are puzzled as to what bonds are. In one word a bond is a loan. The loans can be form the federal government, a federal agency, municipality, or corporation. When you purchase bonds you are lending your money to whomever you buy the bonds from. In return for lending them your money you are paid a fixed rate of interest over a set period of time. When the bond matures the investor’s money is usually returned with the earned interest included. Bonds are like stocks because they are both traded. Therefore you can buy the bonds after they are originally issued while at the same time you can sell bonds before they mature. Bond prices are subject to volatility in relation to market conditions.

The Bond Book: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, & More by Annette Thau Provides investors with the information and tools they need to make bonds a comforting, important, and profitable component of their portfolios. Thoroughly revised, updated, and expanded from its bestselling first edition, this all-in-one sourcebook includes: A new section on using the Internet to research, buy, and sell bonds A new chapter devoted to increasingly popular foreign bonds Detailed information on the inflation-linked Treasury bonds Explanation of the new categories of bond funds Tips on how to evaluate and buy bond funds

When a person is issued a bond they are basically promised to get their money back. Bondholders are paid before anyone else, even stockholders and creditors if the company runs into hard times or goes bankrupt. Bonds give you a stream of income based on their rate of return. Bonds are usually much less volatile then stocks are. Bonds also can provide a tax break because municipal and government bonds are sometimes exempt from state and federal taxes.

The main disadvantage to bonds is that they generally have lower returns than stocks and mutual funds. Bonds are like stocks because their prices are sensitive to interest rates as well. Bonds also carry with them some heavy terminology, which can be confusing and hard to understand.

Type of Bonds:

• Government Bonds
  The U.S. Department of Treasury and other federal agencies issue treasuries and federal agency bonds. Treasuries are basically risk free because the U.S. government backs them. They are issued to help finance all of the costs involved in operating the government. Municipal Bonds – State and local governments to help pay for schools, streets, highways, hospitals, bridges, airports, and other public works issue municipal bonds. You usually don’t have to pay federal taxes on the interest earned from municipal bonds.
• Corporate Bonds
  Corporate bonds are issued by businesses to help pay for business expenses. There are a ton of different corporate bonds available all with their own interest rates, maturities, and credit ratings. Corporate bonds are generally higher risk bonds in comparison to municipal and government bonds. They also have a higher rate of return than municipal and government bonds. However you do have to pay taxes on the interest earned from corporate bonds. Municipal bonds are issued by more than 50,000 state and local governments and their agencies to fund projects such as schools, streets, highways, hospitals, bridges, and airports.

Bonds and Bond Derivatives by Miles Livingston Provides an introduction to bond markets and bond derivatives for students as well as for executives in commercial businesses and financial institutions. While many topics about debt instruments involve mathematics, this text presents the essential elements in an intuitive manner. Containing material that is accessible and engaging to students and practitioners alike, the book is ideally suited for debt markets courses, and provides a good fit with any finance curriculum....

Related Post:

• Why is Your Mix of Stocks & Bonds so Important?
• What is Bond Ratings
• Basic Investment Strategies
• Knowing Your Bonds by Reading the Yield Curve
• What is a Tax Free Municipal Bond?

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Why is Your Mix of Stocks & Bonds so Important?

Historically, stocks and bonds tend to move in opposite directions. In other words, when stocks take off for the stratosphere, boring old bonds get left in the dust. Why would anybody bother with a few dinky percent return when you can strike it rich in the stock market gold rush? But then, as happened when the dotcom bubble burst, people stampede to get out of stocks. And where do they put the money? Right - the stodgy but relatively reliable bonds. When one zigs, the other tend to zag.

The underlying cause for this is not only the psychology outlined above. Interest rates, as dictated by the Federal Reserve, further reinforce this phenomenon. When things are going well, the Fed wants to keep the economy from overheating. The primary way to do this is to hike the interest rates. This makes borrowed money more "expensive" which cools off the growth to a reasonable level.

Unfortunately, this is bad news for someone holding bonds. Since a bond is essentially an IOU with a set interest rate, your existing bond is suddenly less worth than a new, freshly minted one. If the IOU in your pocket you bought yesterday has a 6% interest rate and a new one today has 7%, you probably feel a bit gypped. And if you bought shares in a bond fund, which is what most of us choose to do, the value of your fund shares take a hit with each rate hike.

On the other hand, the Fed is quick to slash the rates when the stock market takes a tumble. Then you're suddenly sitting pretty with an IOU that brings in MORE than a new bond would, and for a bond fund the value of your shares go up.

With this in mind it is easy to see why bonds work as an effective hedge against stock market swings. If you keep 30% of your savings in bonds and 70% in stocks, you will do well when the stock market rallies. The 30% in bonds will not grow as fast as your stocks, but at least you have a reliable dividend income to fatten up your bottom line. However, when things head south those 30% in bonds will provide a soft cushion. While you may be 20% in the red on your stocks, the OVERALL situation isn't so bad once you consider the appreciation of your bonds and the good old cash dividends.

However, not all bonds are created equal. These IOUs have different lengths, which affects how much the prices will swing. If you have a bond that is due in one year, you are less vulnerable to sudden price swings. A 30-year bond bought at the peak or bottom have many years to either underperform or exceed the rest of the market, which makes the impact of rate changes the more forceful.

Another thing to consider is the class of bond. A US Treasury bond is about as safe as they come - you know Uncle Sam will pay up next year - or 30 years down the road. A corporate bond in a struggling company may go belly-up before you get to cash in your bond, but on the other hand you may get twice as much return on your investment. The more risk you take, the juicier the potential returns.

For most people, the easiest choice is to go with a bond mutual fund. There, you only have to decide between short, medium or long term investment, and whether to go with a treasury, muni or corporate bond portfolio. Some companies have different specifics on what is what, so you're wise to do your homework to find the fund that works best for you. Vanguard and Fidelity are respectable bond fund companies to consider.

Last but not least, what is the ideal balance between stocks and bonds in your portfolio? There is no one-size-fits-all answer to that. Some claim your age is a good indicator: a 30-year old should have 30% bonds, a 55-year old should have 55% bonds. I think that's a bit too simplified. If you have a stable economic situation and don't mind taking risks, you can be 60 years old and have 90% in stocks and only 10% in bonds, while a risk-averse 25-year old doesn't have to be ashamed about an even 50/50 split between stocks and bonds. The bottom line: the more risk you can tolerate, the higher percentage of stocks you should have.

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Basic Investment Strategies

Everyone should have a financial plan that includes long-term investment strategies. These can range from no risk to significant risk, depending on the type of program you decide to invest in.

Guide to Investment Strategy: How to Understand Markets, Risk, Rewards And Behavior by Peter Stanyer, Elroy Dimson With detailed analysis supported by data and anecdotes drawn from investment experiences, this practical guide emphasizes the importance of basing recommendations for investment strategy on the principles of traditional finance.

Before sinking your hard-earned funds into an account that may not hold up during times of economic uncertainty, explore some of the available options to make the best choice for your investment dollars.

The New Investment Superstars: 13 Great Investors and Their Strategies for Superior Returns by Lois Peltz New Investment Superstars provides you with a unique opportunity to get to know these market masters and learn the original investment strategies they have used in many markets to outperform their peers.

The safest type of investment plan is a simple bank savings account. Since the federal government insures most financial institutions of this type, you should not fear losing your deposits or the interest they earn. However, the return on this investment is quite small, especially when the economy slows.

Savings bonds are another safe but slow investment. They mature after seven years, doubling in value. These provide a great option for teaching children how to save by purchasing small bonds and watching them grow over time. Other types of bonds, such as municipal or treasury, are slow-growing and involve little risk.

The next level of investment is the certificate of deposit, or CD. These accrue interest at the prevailing market level, which usually follows the current prime rate. Insured by the FDIC, they provide a safe investment but offer a relatively small rate of return. However, there is no penalty for early withdrawals except quarterly interest, so your money remains “liquid,” or available when you need it.

Individual retirement accounts, or IRA's, are long-term savings plans that, generally speaking, become available (with interest) when a person reaches retirement age. There are penalties in terms of lost interest with early withdrawal.

The Only Guide to a Winning Investment Strategy You'll Ever Need: The Way Smart Money Invests Today by Larry E. Swedroe Contains a new chapter comparing index funds, ETFs, and passive asset class funds, an expanded section on portfolio care and maintenance, the addition of Swedroe's 15 Rules of Prudent Investing, and much more.In clear language, Swedroe shows how the newer index mutual funds out-earn, out-perform, and out-compound the older funds, and how to select a balance "passive" portfolio for the long hail that will repay you many times over.

Purchasing stock shares of a publicly traded company is another way to invest your money to make money when the company does well. Profits are distributed to stockholders as dividends or can be compounded into the stock holding to accrue a greater amount of interest over time. Depending on the company's stability and the economic climate as well as the number of shares you hold, stock holdings can be a volatile or safe investment. Become familiar with the company so you have an idea of what to expect.

Mutual funds are an attractive and popular investment option for long-term moneymaking dividends. A mutual fund is actually a portfolio of varied stocks that is compiled by a broker who advises the client about what to buy, sell, or hold. Since mutual funds include a diversified array of stock shares and compound with interest, they can be a relatively secure investment. But there are low risk, moderate risk, and significant risk options. You can invest in American companies or acquire international portfolios comprising European, Asian, or Pacific Rim stock holdings, for example. Ask a broker for details on the best plan for your interests.

Start saving for the future by investing money in an account that will a rate of return that suits your temperament. You can begin with a savings account, progress to an IRA, and put a little aside for riskier ventures in the stock market. An important rule of thumb is never to invest what you cannot afford to lose.

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What is Bond Ratings

When any lending institution makes a loan to a consumer for an expensive purchase like a house or a car, the institution evaluates the borrower’s credit. Since the goal is for the institution to be paid back in full with interest, the institution tries to make sure that the borrower is currently financially able to meet the payment schedule and that the borrower has a track record for paying back loans on time. In other words, the bank or other institution evaluates the credit risk of any loan made to that borrower. Credit risk is a measure of the likelihood the borrower will default on the loan, causing the lending institution to lose money.

The Bond Book: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, and More by Annette Thau Provides investors with the information and tools they need to make bonds a comforting, important, and profitable component of their portfolios. Thoroughly revised, updated, and expanded from its best selling first edition, this all-in-one sourcebook includes: A new section on using the Internet to research, buy, and sell bonds A new chapter devoted to increasingly popular foreign bonds Detailed information on the inflation-linked Treasury bonds Explanation of the new categories of bond funds Tips on how to evaluate and buy bond funds

Bond ratings are a gauge of the credit risk you take as a bond purchaser. When you buy bonds, you are essentially making a loan to the issuer of the bonds. As an investor in bonds, your goal is to get your money back with interest. If the government, municipality, or corporation that issued your bond becomes insolvent and cannot pay what it owes to its creditors, you stand a chance of losing all or part of your investment. Thus it’s important that you have a means of determining the credit risk associated with a particular bond issue before you buy.

Fortunately, as an investor you don’t have to dig deeply into the financial records of organizations issuing bonds to assess their credit risk. Just as there are companies that provide banks and mortgage companies with credit reports on individual consumers, there are companies that specialize in doing the research required to provide credit reports on bond issuers. These companies investigate the financial condition of the issuers, their management practices, and their strategic plans in light of current economic and political conditions. A bond rating represents the sum of their findings.

The three major companies that rate bonds are Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings. Bonds are rated when they are first issued and when the circumstances of the issuing organization change significantly. The conclusions of the three ratings companies are often the same, but not always. Moody’s, S&P, and Fitch have slightly different ways of notating their ratings. All of them rate bonds on a scale from highest to lowest quality. In general a high quality bond is one that has a low likelihood of default, but pays less interest than a low quality bond. As an investor you get rewarded for accepting more risk if things go well.

The rating scales listed here are ordered from the highest to the lowest degree of safety. The greatest credit risk is associated with the lowest rating. For example, an AAA or Aaa rating indicates the safest possible investment grade bond with almost no chance of default. A rating of B or B2 indicates a very speculative choice. When you get down to C and D ratings you are looking at issuers already in default or looking like they’re headed that way.

Moody’s: Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C

Standard & Poor’s: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, D

Fitch: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-, CCC, DDD, DD, D

Bonds with BBB/Baa and above ratings are usually considered “investment grade.” Bonds with ratings of BB/Ba and below are considered “below investment grade” or “speculative” bonds. These lower-ranked bonds are also called “junk” bonds, reflecting their high credit risk, or “high-yield” bonds, reflecting their potential returns.

Related Post:

• What is a Tax Free Municipal Bond?
• Knowing Your Bonds by Reading the Yield Curve

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