Bond: A debt instrument in which the issuer promises to pay to the bondholder principal and interest according to the terms and conditions of the bond.

WHAT ARE BONDS?

A bond is a loan and you’re the lender. Usually, the federal government, a state, a local municipality or large corporation are the borrowers. They need money to operate and to fund future projects and growth. So they borrow capital from the public by issuing bonds.

TYPES OF BONDS

U.S. Government Bonds
The United States Treasury sells bonds to finance the federal government. The bonds issued by the US government are called Treasuries. They’re grouped in three categories.

• U.S. Treasury bills — maturities from 90 days to one year
• U.S. Treasury notes — maturities of more than one year to 10 years
• U.S. Treasury bonds — maturities of more than 10 years.
• U.S. Treasury bonds — maturities of more than 30 years.

Because the U.S. government has never failed to pay its debt, these bonds are considered to be some of the safest you can buy. And there’s another benefit to Treasuries: The income you earn is exempt from state and local taxes. You can buy EE Bonds and I Bonds through most financial institutions and through the Payroll where you work.

Types of US Bonds:

• EE Bonds. These are discount bonds. When you buy these bonds, you pay only half their face value, (the value printed on the bond). For example, you pay $100 for a $200 bond. Each year that you keep the bond, its value increases as interest adds up. Even after the bond reaches the value stamped on it, the bond will continue to earn interest. Bonds earn interest for 30 years from the date they were issued.
• I Bonds. These bonds are sold at their face value ($100 for a $100 bond). They earn interest and can be cashed in to pay for college. They are tax-free. With this type of bond, the interest rises and falls every six months or with every interest rates change.
• HH bonds. Unlike paper EE Bonds, HH Bonds are current-income securities. They pay interest every 6 months until maturity or redemption whichever comes first.

Mortgage-Backed Securities

Mortgage bonds are issued on the basis of the Law On Mortgage Bonds that guarantees the safety of investments. Mortgage bonds are public circulation fixed income debt securities issued by bank and covered by mortgage loans of high quality. These bonds have uncertain maturities because people pay back mortgages before the end of the mortgage. All have irregular monthly payments that may include both interest and principal.

The main characteristics of the mortgage bonds are the following:

• Safety of investments
• Liquidity
• Yield

MUNICIPAL BONDS

Municipal bonds are a small step up on the risk scale from Treasuries, but they make up for it in tax benefits. State and local governments and government-related agencies (schools, water, bridge, highway authorities) sell bonds to raise money for a variety of purposes. After U.S. Treasuries, municipal bonds are considered the safest. Thanks to federal guidelines, the government can’t tax interest on most state or local bonds (and vice versa). Bonds for private purposes however, (sports stadiums, airports, hospitals, industrial parks) may not be income tax-exempt.

CORPORATION BONDS

Corporations sell bonds to raise money for major projects. Corporate bonds pay higher interest because corporations cannot tax to raise money. Corporate bonds are generally the riskiest fixed-income securities of all because companies are much more susceptible than governments to economic problems.

Corporate bonds have no income tax advantages, thus, usually have higher yields.

Corporate’s come in several maturities:

• Short term: one to five years
• Intermediate-term: five to 12 years
• Long-term: longer than 12 years

Standard & Poor’s and Moody’s Investors Service monitors credit quality of companies and governments closely. They assign credit ratings based on the entity’s perceived ability to pay its debts over time. Those ratings — expressed as letters (Aaa, Aa, A, etc.) — help determine the interest rate that company or government has to pay. The higher the rating the higher return value.

SPECIALTY BONDS

Variable rate bonds, convertible bonds, and zero-coupon bonds are some examples of specialty bonds.

Zero-coupon bonds are fixed-income securities that don’t make interest payments each year like regular bonds. Instead, the bond is sold at a deep discount to its face value and at maturity, the bondholder collects all of the compounded interest, plus the principal.

Why would you want to do that? Because at maturity the face value of a zero-coupon bond is more than the issued purchased price. However, there are no interest payments made to the investor. The value of the bond increases each year. Zeros do have a tax drawback, however, unless you hold them in a tax-deferred retirement account or an education IRA. Since interest is technically earned and compounded semiannually, holders of zeros are obliged to pay taxes each year on the interest as it accrues. That means you have to pay the tax before you get the money, which might be a struggle for some investors.

PORTFOLIO REVIEW

How much of your portfolio should be in bonds? Your age, income, and investment objectives will answer this question: Investors should review their portfolios from time to time to make sure that their portfolio asset allocation continues to meet their investment objectives.

HOW TO BUY BONDS

When buying bonds, consider five factors in relation to your savings goals:

• Investment objective: If you are looking for long-term growth, bonds do not match your objective. However, if your objective is safety of principal and you want to earn current income from your money, bonds would match your objective.
• Buy different maturity levels That way you will have a bond maturing in each year and if you need money, you won’t need to sell a bond at a reduced price (discount) before maturity.
• Investment diversification Stocks and bonds tend to move in opposite directions. When the stock prices go up, bonds go down; when bonds go up, stocks go down. Over the long haul, this low correlation between stocks and bonds permits a portfolio to even out the highs and lows and can result in an overall higher return.
• Compare the yields of bonds 
  • a. Yield to maturity is one way to compare bonds on the basis of time.
  • b. Yield to call expresses the return to the call date considering any premium paid for the bond when called and the premium or discount paid for bonds when purchased.
  • c. Duration will compare bonds with different coupons and different terms to maturity.
• Risk evaluations The risks associated with bonds are tied to several factors. There are interest-rate risk, credit risk, call ability risk, reinvestment rate risk, and inflation risk. The safest bonds are short-term (less than 5 years) Treasury Bills followed by other short-term government bonds. The riskiest bonds are long-term bonds (12 years­40 years), junk bonds, and high yield, or high return bonds.

KEY POINTS

• Liquid long-term investment
• Easy to buy
• Safe and secure
• Market-based investment
• Used for education services
• They have tax advantages
• They’re great for United States government
• Pay higher interest rates
• Less volatility
• Regular income
• Sold in small dollar amounts (U.S. Savings Bonds—$25, $50)
• Easy management

IN CLOSING

There’s no time like today to begin saving to provide for a secure tomorrow. Whether you’re saving for a new home, car, vacation, education, retirement, or for a rainy day, U.S. Savings Bonds can help you reach your goals with safety, market-based yields, and tax benefits.

FINDING A FINANCIAL ADVISOR
A financial advisor can ensure you’re saving enough to meet all your immediate and retirement needs. Find out what’s best for you and your retirement goals! Learn more about the different asset allocation types, explore the areas above and fill out our online form to find a certified financial advisor in your area.