Investing in Bonds
Bonds are known as fixed-income securities because their income is fixed at the time the issuer sells them. When you buy a bond, you're lending the bond issuer money in return for a fixed rate of return. This interest is usually paid quarterly but is sometimes paid at the maturity date, when the issuer repays the principal it borrowed from you. Corporations, states, cities, and governments all issue bonds for the same reason companies issue stock: to raise money for operations, expansion, or other financial needs.
Bonds are rated for safety by bond-rating companies and given a grade between A (low risk) and C (high risk) to indicate the likelihood that the issuer will pay the interest and principal as promised. Look up ratings at A.M. Best (
Risk Level of Bonds
Bonds issued by the federal government are extremely safe. Some corporate bonds are safe and others are high-risk. High-yield bonds pay a higher interest rate, but their nickname of “junk bonds” should give you fair warning of their risk. One of the risks associated with bonds is related to interest rates. If you lock in your money for a number of years at a fixed interest rate, you could be stuck if market rates go up. You may not be able to sell the bond for full price if other bonds are paying higher interest rates.
Municipal bonds are issued by states and cities to fund projects such as road repairs, bridge building, prison renovations, and any number of other projects requiring large amounts of money. These bonds aren't guaranteed, but defaults are rare. Earnings are exempt from federal income tax, which makes them attractive to people in a high tax bracket.
How to Buy Bonds
You can buy federal government bonds, including U.S. savings bonds, directly from the U.S. Treasury, and both government and corporate bonds through a stockbroker. If you don't want to buy individual bonds, you can buy shares in a bond fund, which invests in a number of different bonds. You'll incur fund expenses that will eat at your return, so bond funds are best if you'd rather pay a fee for broad diversification and professional management instead of choosing the bonds yourself.
Series EE U.S. Savings Bonds
U.S. savings bonds aren't the most exciting investment in the world, but they may have their place in your portfolio. Their appeal is that they're fully backed by the U.S. government, they're free of state and local income taxes, and they're federal income tax — deferred. You won't get rich buying U.S. savings bonds, but neither will you lose your shirt. You can buy them at banks and financial institutions, through many employers' payroll-deduction programs, through automatic debits from your checking or savings account using the EasySaver program, or directly from the U.S. Treasury online at
Bonds issued by the U.S. government are considered to be the safest bonds available. The assumption is that the U.S. government will not go out of business and fail to pay as agreed. Some bonds may fluctuate in price, but principal and interest payments are guaranteed.
There are several different types of U.S. savings bonds. You purchase Series EE bonds at one-half the face value (a $50 bond costs $25) in denominations of $50, $75, $100, $200, $500, $1,000, $5,000, or $10,000. The interest rate changes every six months and is based on the yield on five-year U.S. Treasury securities.
At the U.S. Treasury Web site at
Series I U.S. Savings Bonds
I bonds are similar to EE bonds but are issued at face value (a $100 bond costs $100) and the interest is paid when the bond is redeemed. You can purchase up to $30,000 of I bonds in a year. Your return is based on two factors: a fixed rate (set when you purchase the bond) and an inflation rate. If inflation is high, the interest you earn during that period will be higher. Likewise, as inflation decreases the interest you earn decreases.
U.S. Treasury Securities
Unlike U.S. savings bonds, U.S. Treasury securities (bills, notes, and bonds) can be transferred from one person to another, so you can buy and sell them in the securities market. They provide steady income, flexibility, and security. Treasury bills (or T-bills) mature ninety days to one year from their issue date. You buy them for less than their face value, and you receive full face value when they mature. Treasury notes pay a fixed rate of interest every six months until maturity, which is from one to ten years.
Savings bonds are meant to be long-term investments. You can cash them in after you've owned them for one year, but you should wait at least five years. Before five years, you'll pay a penalty equal to three months of interest payments.
Don't Go Overboard
U.S. savings bonds and Treasury securities have a place in your portfolio, but are too conservative to get the lion's share of your investment money. Use them for your cash savings. You'll earn more interest than you would on savings accounts, and Series I bonds can help protect you from inflation. Once you've built your portfolio, you can also use them for long-term investments to balance more aggressive and riskier investments, such as stocks.
