Are you interested in investing in corporate or government bonds? The bond market is the largest securities market in the world and it provides endless possibilities for investment. However, new products are constantly entering the market all the time making it hard for even the most astute investor to stay on top of the game! We’ve compiled a mini-guide on bond investment covering everything from what bonds are to how to figure out if they’re the right investment opportunity for you.
Remember, if you’re thinking about investing for the first time you should always seek the advice of a financial advisor first. You don’t need to book an appointment in person to get started, there are many great resources online to help you. Through a financial advisory website like the Motley Fool, you’ll gain access to amazing resources on financial investments curated by their financial experts. With this great Motley Fool discount, you can even save on your first membership!
What are bonds?
A bond is essentially a loan one makes to an entity, such as a government or cooperation. Bonds are typically issued to raise funds for specific projects. Just like any other loan, repayments are made regularly on the loan, including interest, and the principal is paid at a known time. There are three types of bonds:
- Corporate: This is a loan made to a corporation. They are usually high risk / high reward since a company is more likely to default on the loan than the government. The interest you earn from corporate bonds is taxable.
- Municipal: These are loans issued by local municipal governments or cities, usually to fund some sort of public works project.
Treasury: These are bonds issued by the federal government. The interest you earn from treasury bonds are not subject to state and local taxes.
How can you make money investing in bonds?
Unlike stocks, bonds are not traded ‘over the counter’ meaning that you will need to hire a broker if you want to start investing in bonds. The only exception is Treasury bonds which you can purchase directly from the Federal government.
What are the benefits to investing in bonds?
Risk versus reward: Like most forms of investments, the larger the risk you assume the higher the chance that you’ll be greatly rewarded. Some bonds like treasury bonds are very safe since they can’t be defaulted on, but that comes at the cost of lower interest rates. Corporate bonds offer the highest interest rate but they can be risky since a corporation can default on the loan. It’s up to you to weigh the risks carefully and determine how much risk you’re willing to assume.
The maturity rate: Many bonds are set up with a maturity rate of 30 years. That means you won’t see the principal you invested for that length of time. There are short-term bonds available that mature within 5 years, but they don’t pay high interest rates.
Taxes: One of the major benefits to bonds is that you won’t pay taxes on your interest. The US federal and municipal governments struck a deal a long time ago not to tax each other’s bonds. So if you invest in a municipal bond, you won’t have to pay federal taxes on your interest and vice versa. The only exception to this rule are corporate bonds.
Diversification: Another major benefit to investing in bonds is the ability to diversify your investment portfolio. Many people choose to invest in bonds alongside stocks since they tend to do well in opposite conditions. By diversifying your portfolio with different kinds of assets, you can ride out any bumps in the market relatively unharmed.
Read More: Financial Planning Tips For the Whole Family