Choosing the Right Type of Bond

If you’re relatively new to the culture and climate of investing, you may have questions about how to begin building your investment portfolio, and what you should be investing your money into. Even if you have prior investment experience, it never hurts to brush up on the basics, which is why this article is designed for anyone who wants to learn (or refresh themselves) about the different types of bonds available.

Some Important Features of Bonds

Bonds can help you to build and maintain a diversified portfolio, generate income, and more effectively manage market fluctuations. Some important features of bonds that are generally available to individual investors are:

• Credit quality of the issuer
• Coupon Rate
• Length of time between the date the bond is purchased and its maturity date
• Whether or not the interest paid is fully taxable
• Whether the bond may be prepaid prior to the maturity date

Types of Bonds

Generally, bonds are categorized by how they are issued. The four most common types of bonds are U.S. Government Securities, Mortgage Backed Securities, Corporate Bonds, and Municipal Bonds.

US Government Securities

These bonds are issued by the U.S. Department of Treasury and obligate the government to pay the bondholder a specified sum of money, at specific intervals, and to repay the principal amount of the loan by the specified maturity date. There a few different types of US Securities and these types include:

• US Treasury or T-Bill
• Issued in denominations of $1000. Keep in mind, though, that brokerage firms may impose a minimum purchase order.
• Interest is generally exempt from state and local income taxes
• Interest is paid at maturity and is the difference between the cost to purchase the bill and the face value received at maturity.
• Maturity dates are typically from 90 days to 1 year.
• This type of US Security is a negotiable debt obligation issued by the US Government and backed by its full faith and credit

U.S. Treasury Note:

• Negotiable debt obligation issued by the US Government and backed by its full faith and credit
• Maturity dates can range from 2-10 years
• Interest is paid semi-annually
• Issued in denominations of $1000 although brokerage firms may impose a minimum purchase order

U.S. Treasury Bond:

• Negotiable, coupon-bearing debt obligation issued by the US Government and backed by its full faith and credit
• Interest is paid semi-annually
• Maturity dates range from 2-10 years
• Issued in denominations of $1,000 although brokerage firms may impose a minimum purchase order

U.S. Government Issued Zero-Coupon Bond: (Also known as an Accrual Bond)

• These bonds issue at a discount that varies depending on the length of the maturity
• Taxes due are due annually on accrued interest (except in certain cases, such as with tax-exempt municipal zeros)
• Pays no interest, but pays a higher par value at maturity than the face value at issue

Savings Bond or U.S. Savings Bond:

• Registered, non-callable, non-transferrable bond issued by the U.S. Government and backed by its full faith and credit
• Issued in three types, which are: Series EE, Series HH, and Series I
• Face value ranges from $50-$10,000
• Interest Payments are exempt from State and Local taxes.

Mortgage-Backed Securities

Mortgage-Backed securities are securities created by pooling mortgage debt and selling it as individual bond securities, and for this reason, mortgage securities tend to be higher risk investments than other bonds and are often priced to achieve a higher yield. Unlike with other types of bonds that pay the principal upon maturity, mortgage-backed securities feature principal and interest payments that are paid periodically. This prepayment is a special risk to consider before investing in mortgage securities.

Corporate Bonds

Corporate Bonds are issued by companies to raise capital, and tend to be higher risk and carry a higher yield bond issue than most government bond issues with similar maturity dates. Ratings services, like Standard and Poor, assign a corporation’s bond rating based on their perception of whether a debt issuer will be able to meet scheduled principal and interest repayments, so this information is something to look into before investing in this type of bond.

Some additional features of Corporate Bonds include:

• Minimum purchase is typically $5,000
• Subject to local, state, and federal taxation
• Par value of $1,000

Municipal Bonds

Municipal Bonds are bonds issued by state and local governments in order to fund civic products, and for the public, investing in municipal bonds carries the potential advantage of being interest-exempt from federal and/or state income tax. Some exceptions do apply, including those involving alternative minimum taxes, and any capital that is earned from the sale of municipal bond is in itself fully taxable and subject to being taxed as income depending on the discount at the time of purchase. Your financial advisor can help you calculate the taxable equivalent yield, which is needed on a taxable investment in order to match the tax-free return offered on a municipal bond, in order to determine whether this type of bond is right for your investment purposes.

Investing Wisely For The Future

With this guide to the most common types of bonds available, you are well on your way to making a smart and informed investment decision at your next meeting with your certified financial planner. Remember, your investment choices today directly impact your financial future and options in the future.