Why Are Bonds Less Risky to Buy

Bonds are a popular form of investment that are considered much less risky than many other investment options. This is because they return your initial investment when they mature and because they pay out regular interest. You should understand that a bond that is issued by a company that has poor credit may be considered considerably higher in risk. They may not repay your principal and may suspend interest payments. Values of bonds may fluctuate over time and if you need to sell the bond before its maturity date then you may lose money on the investment.

Bond investments are simply loaning money to the company that issues the bond. Loans in themselves carry interest rates and maturity dates which is the date in which the loan must be paid in full. Bonds are different from traditional bank loans however in the way that they pay interest. Interest payments on bonds are made twice each year and the repayment of the principal is only paid upon maturity. Bonds are fixed income securities because the interest that is paid on the bond is fixed when the bond is issued and that interest is paid regularly.

Investing in bonds is considered to be much less risky than investing in stocks because the principal amount is paid back in full when the bond matures. Bonds come in different maturities. Treasury bills, banker’s acceptances and commercial paper have maturity dates of less than one year and bear interest. These are not commonly referred to as bonds however. Those that have maturity dates that range from two to nine years are known as Notes. Only those that have maturity dates lasting ten years or longer are known as Bonds even though most consider any fixed income security to be a bond.

Treasury Bonds are issued by the Treasury Department. These are considered to be the best quality and offer the highest credit quality available. The interest that you receive from treasury bonds is not taxable for state income taxes. Corporate bonds are those that are issued by corporations and typically have fairly high credit ratings. Ratings are from high quality or AAA, medium quality or BBB or low quality or CCC. These lower quality bonds are referred to as junk bonds. Interest income received from corporate bonds is taxable and they are subject to credit quality risks as well as risks from the market rates.

Municipal bonds are those that are issued by states and/or municipalities and carry about the same credit ratings as corporate bonds. Mortgage backed bonds are also known as pass-through bonds and are a bit different from straight bonds in that they do not pay back the principal at maturity. Instead they pay back principal and interest at regular schedules throughout the term of the bond. Mortgage backed bonds are subject to market rate risks if they are sold before maturity and they tend to decrease in value as they grow closer to their maturity date.

Purchasing bonds is a fairly simple process, particularly if you have an online account with a broker. US Treasury bonds are the simplest to purchase because they are available at all times through any bank or through the Treasury website. Municipal bonds can be purchased through different larger banks as well as brokerage firms and corporate bonds are typically purchased through a brokerage house. Take your time when choosing the bonds that you will purchase to ensure that you make wise investment decisions. If you are purchasing through a brokerage house it is recommended that you do a bit of research in order to find the best institution for handling your investment.

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