Bonds
Bonds are tradable instruments (debt securities) issued by companies or governments to raise capital that guarantee payment of the original investment plus interest by a specified future date. Bond certificates act as evidence of a debt on which the issuer promises to pay the holder a specified amount of interest for a specified length of time, and to repay the loan on its maturity.
Bonds with the least amount of risk include U.S. Treasury bonds, which are used to finance the federal government, and mortgage-backed securities, which includes Ginnie Mae, Freddie Mac, and Fannie Mae. State and local governments also issue municipal bonds to finance the construction of public works projects, some of which are free from federal income tax and may not be taxed by state and local governments.
Other bonds include corporate bonds, which pay higher interest but have no tax advantages, and specialty bonds (such as variable rate bonds, convertible bonds, and zero-coupon bonds). Zero-coupon bonds are bought at a discount and the face value is more than the issued purchased price at maturity. However, there are no interest payments, and even if the interest is not received by the investor, the interest is taxable as current income.
On the plus side, bonds offer regular income, higher interest rates than savings accounts, a relatively safe return of principal, and are often less volatile than stocks, especially in the short term.
On the negative side, bonds have lower returns than stocks over the long term and they offer no hedge against inflation. That’s because inflation causes interest rates to rise, which then causes bond prices to fall. Also, taxes will be owed on capital gains or losses (selling before maturity) and interest unless the bonds are tax-exempt.
To learn more about bonds as investment opportunities, click below.
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