Definitions in personal finance and investment: Bonds

Definitions in personal finance and investment: Bonds

Whenever you hear about portfolio diversification, the types of investments mentioned always include bonds. We explain what they are, how they work, and why (and when) bonds are a good option to buy.

A bond, simply put, is a loan to the government. When you buy a government bond you are lending money to your government. They pay you back by giving regular interest payments on your bond, and returning the full face value amount of your bond at the date of maturity. So, it works like a loan, where you are the lender.

A global thing

All countries issue their own bonds. Within those countries some cities are also allowed to issue city bonds, to raise funds for those cities. Some corporations also issue bonds instead of shares.

In the United States, when there is talk of bonds, it can mean one of four things.

Savings bonds

They’re the consumer approach to binds. Their price starts at $50.

They have the longest maturity terms of all government bonds. The current bonds on sale by the United States government are those of Series I, with a maturity of 30 years. They are a good and safe way to spend without risk. You may redeem them before their full maturity: However, if that is the case you won’t get the full interest payment from the bond, and will be charged a small penalty for early exchange.

Treasury bills

Also known as T-bills, these are short term bonds that mature within one year. They work differently from savings bonds, in that they don’t grant dividends; instead, they grow on par from their discounted sale price. Another difference is that the Treasury sells them on auction, not regular sale via financial institutions, as is the case with bonds.

Here’s an example of how a T-bill works: The government puts X amount of $10,000 T-bills on sale, and you’re interested in investing. You place a bid for less than their face value (the $10000). The highest bidders win. This way, you can get a $10,000 T-bill for $9,600, $9,700, $9,800 and so on, depending on how the conditions are on the days of sale. When the bond expires, the government gives you the full $10,000 face value of the bond. That way, you earn the difference between its face value and what you paid for it.

The smallest T-bill is $100.


Treasury notes

Treasury notes or T-notes work the same as T-bills but have greater maturity terms, between one and ten years. The 10-year Treasury note is the most followed of all securities, and many banks use their current prices to set mortgage rates. Treasury notes also sell at auction, but differ from treasury bills in that earn interest, like a savings bonds do. However, whereas bonds give interest quarterly, Treasury notes do so every six months. They come in denominations of $1,000.

Treasury bonds

Also known as T-bonds, you shouldn’t them with savings bonds. Th U.S. Treasury issues them directly, and they’re extra long-term securities, with terms of 20 or 30 years. They give interest semi-annually, and their starting face value is $1,000.

Tax considerations

The interest earned from any of the bonds issues by the U.S. Treasury is exempt from state and local taxes, but subject to federal tax. Keep that in mind when investing in bonds.

Why should I buy bonds? And when?

From an individual investor’s point of view, the government bonds of most nations are a very safe bet, if a tad boring. After all, you have a guaranteed safe return on your investment.

If you’re near retirement or retired and have extra cash, bonds are a good choice. They can just gather interest on their own (savings bonds) or provide you semiannual payments of dividends that can be a tidy addition to your monthly income. And, as I said, they are a safe bet.

Another good time to consider purchasing some bonds is when stocks are soaring. I am not going to explain why today, but know this: when stock prices are high, Treasury bill prices are low, and vice versa. So, Treasury bills are good to buy when the stock market is doing well and stocks are overpriced. The greater the discount, the more you make at maturity.

Consumer bonds as investments are an attractive option when the markets aren’t doing well, or when the economy is near or in recession. They have the backing of the treasury so that you have a pretty safe bet when purchasing them.

If you’re interested in weighing your investment options, remember that through the partnership with Cetera Advirsors, you can receive a free consultation with no commitment on your part.

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